2010 Morning Question 1 - Pretax return with TDA

CFA Level III
#1

I saw a few other threads related to this question, but I can’t wrap my head around it.

Salary is 140,000 pre-tax

Expenses are 96,000

Contributes 12,000 to TDA (pretax contribution) each year

Taxes are 25%

Exam question: Calculate PRETAX nominal rate of return.

Steps:

1.) 96,000 expenses, shored up for taxes (96/.75) = 128,000

2.) 140,000 salary - 128,000 shored up expenses = 12,000 left over for contribution to TDA

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My question: do we always have to use AFTER TAX income to pay for expenses? The question asks for the pretax return!

I’d appreciate anyone trying to explain this. I understand the pretax contribution to TDA but not the shoring up of expenses (are expenses after tax?) Thanks

#2

Most living expenses are met through after tax income.

#3

Isn’t is assumed that living expenses are after tax, and met through after tax income?

#4

It does seem that way. I guess I hadn’t run into this issue before, since the question asks for pre-tax return, but they give you pre-tax income and expenses. Thanks

#5

when you go to the grocery store and buy food are you using pre-tax or after tax $?

#6

True

#7

I would always assume living expenses are after tax unless explicitly told otherwise.