Reading 10 bluebox example 1

CFA Level III
#1

This text that follows is from the book reading 10 bluebox example 1:

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If I was looking at strictly gross return requirement, why does this not work?

10.8% gross total required return : 2,000,000 * (1.108)7 = 4,100,230

portfolio value = 14,100,231

gross total income needed = 658,000/(1-T) = 1,012,308

gross total required return = 1,012,308 / 14,100,231 = 7.18%

after tax required return = 7.18% *(1 - T) = 4.68%

This 4.68% is not the same value as 5% from the book.

#2

Couple things quickly identified potential issues.

1.) You do not have a 10.8% compounded return over 7 years when they text says the investment is fully taxable.

2.) After dividing the income need by the asset base, you already have the after-tax required return. This calc is not necessary.

#3

Thanks on point 2. agreed.

But I’m not getting point 1. If she is buying and holding, then 10.8% return calculation is perfectly reasonable. Or reinvesting any gains.

#4

It is true if you are a buy/hold investor, you pay no taxes as long as you don’t sell. In that sense, the account acts similar to a tax deferred account. But you run into major complications with cost basis and various other issues which make the calcuation very complicated. For example, what happens when you clear out your gains and only cost is left? Over a multi-period calcuation, your head would go nuts.

However, the text doesn’t say he only buys equity growth stocks that pay no dividends. The examples in the book are consistent. If it mentions the investments are fully taxed, then you do this:

2,000,000 * (1 + (.108)(1-.35) )7 which is what the text wrote… r = 7.02%

It may mention that only withdraws are taxed (tax deferred account), then you do something else.