In the IPS problems, if there is a down payment of house, stock portfolio, some expenses and salary and we are asked to calculate pre tax return…
Do we calculate the net flow using pre tax income and expenses or from after tax income and expenses… does it make a difference?
also if we do pre tax then do we calculate pre tax for down payment of house, stock portoflio too, by assuming it was given as after tax?
http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91332569
Nice feedback from Bilal. I came to the same conclusions about calculating pre tax return. It should help you.
I applied this here, but something’s wrong… answers dont match…
assets : (curent market value ) : 5000 cash, 160000 stocks and bonds, 220000 in common stock,inheritance:900000
down payment for home: 30000, non tax deductable donation: 20000
annual living exp:74000, after tax salary increases offset future increases in living expense, pre tax salary=80000
In 18 yrs, they need 2000000, calculate pre tax ret
tax rate : 40% on salary, capital gains, inv income
net flow= pre tax living- pre tax sala = 123333-80000=43333
I did this - PV= -1235000, n=18, pmt=43333, fv=2000000
ans 5.6%, pre tax.
however solution is 7.3% pre tax… only difference is the net flow where they do it after tax and at the end do it pre tax by dividing (1-t)
where am i going wrong?
I think that the key issue here is the phrase “after tax salary increases offset future living expenses increases”
It implies that you have to take the difference after tax and at the end divide by 1-t as they did.
how would it matter as the tax rate would be the same for both, so even pre tax salary should offset pre tax living expenses, inflation would also be the same.
I agree with you. However, our problem is to recognise which method of calculation to choose. I just think that this phrase is a hint. IPS calculations are hard, because lack of consistency Institute presents.
anyone.??
What’s particularly frustrating about this is calculating the required return in real life would be easy because you would actually clarify what your client is telling you when discussing these things with them in the first place.
after tax salary increases offset future increases in living expense -> this does not mean that you can work with the after tax expenses - and work backwards to the pre-tax expenses. It is ONLY the increases that match.
instead
pre-tax sal = 80000
after tax sal = 48000
portfolio needs to make up the difference of 26000
and that is the only way to work.
N=18
PV=1,235,000
PMT= -26000
FV=-2,000,000
Cpt I/Y = 4.43% / (1-.4) = 7.38%
cpk but why cant we work with the pre tax expenses and salary…I have seen places where they do compute pre tax expenses for the net flow when pre tax return is asked… why cant we do that here…? Pls assist…
you cannot because they do not give you the entire pre-tax expenses here. they just tell you that any increases are offset by similar after tax increases in salary. you also know they pay 32000 in taxes. but what else is taxed? do you know enough to go there?
this is the case where they give you pre-tax salary, after tax expenses. and asked for after tax rate of return.
so the way to go -> convert pre-tax salary to after tax salary, get excess expenses, use that.
2009 - tracy case - after tax expenses, after tax salary - asked for pre-tax nominal rate of return.
get excess of expenses over income
divide by the “investable assets”
get the after tax nominal rate of return
divide that by (1-t) to get the pre-tax nominal rate of return.
maybe I am missing something here - and S2000 can throw in some more color …