Roberto listed his assets and liabilities on a personal balance sheet.
| | Assets | | Liabilities |
|---|---|---|---|
| cash | $1,800 | credit card | $4,000 |
| investments | $6,200 | personal loan | $1,000 |
| house | $150,000 | mortgage | $100,000 |
| car | $8,000 | car loan | $5,000 |
| Total | | Total |
After creating the balance sheet, Roberto decided to use his investments to pay off his car loan. How will that decision affect the difference between his assets and liabilities?
A. It will make the assets $5,000 less than the liabilities.
B. It will make the assets $5,000 more than the liabilities.
C. The difference between the assets and the liabilities will remain the same.
D. The difference between the assets and the liabilities cannot be compared.
Answer (2)
Calculate initial total assets and liabilities.
Calculate the initial difference between assets and liabilities.
Calculate new total assets and liabilities after paying off the car loan.
Calculate the new difference, which remains the same: T h e d i ff ere n ce b e tw ee n t h e a sse t s an d t h e l iabi l i t i es w i ll re main t h es am e .
Explanation
Initial Assessment Let's analyze Roberto's balance sheet to understand how paying off his car loan with his investments affects his overall financial position. We'll start by calculating his initial total assets and total liabilities.
Calculating Initial Net Worth Roberto's initial assets include cash, investments, his house, and his car. So, his total initial assets are: A i = $1 , 800 + $6 , 200 + $150 , 000 + $8 , 000 = $166 , 000 His initial liabilities include his credit card balance, personal loan, mortgage, and car loan. So, his total initial liabilities are: L i = $4 , 000 + $1 , 000 + $100 , 000 + $5 , 000 = $110 , 000 Therefore, the initial difference between his assets and liabilities is: D i = A i − L i = $166 , 000 − $110 , 000 = $56 , 000
Impact of Paying off Car Loan Now, let's see what happens when Roberto uses his investments to pay off his car loan. He uses $5 , 000 from his investments to pay off the $5 , 000 car loan.
Calculating New Net Worth After paying off the car loan, his investments are now: $6 , 200 − $5 , 000 = $1 , 200 His new total assets are: A f = $1 , 800 + $1 , 200 + $150 , 000 + $8 , 000 = $161 , 000 His car loan is now: $5 , 000 − $5 , 000 = $0 His new total liabilities are: L f = $4 , 000 + $1 , 000 + $100 , 000 + $0 = $105 , 000 The new difference between his assets and liabilities is: D f = A f − L f = $161 , 000 − $105 , 000 = $56 , 000
Conclusion Comparing the initial difference ( D i = $56 , 000 ) and the final difference ( D f = $56 , 000 ), we see that the difference remains the same. Paying off a liability with an asset doesn't change the overall difference between total assets and total liabilities. It simply reallocates the composition of assets and liabilities.
Final Answer Therefore, the decision to use his investments to pay off his car loan will not affect the difference between his assets and liabilities. The difference will remain the same.
Examples
Imagine you're managing a lemonade stand. You have cash (an asset) and a debt to your parents for the lemons (a liability). If you use some of your cash to pay off your lemon debt, you have less cash, but also less debt. The overall value of your business (assets minus liabilities) stays the same. This principle applies to personal finance as well, where understanding how asset and liability management affects your net worth is crucial for financial health.
Roberto's decision to use his investments to pay off his car loan does not change the difference between his assets and liabilities. Initially, he had a difference of $56,000, which remains the same even after the transaction. Therefore, the correct answer is C: The difference between the assets and the liabilities will remain the same.
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