Guideline Answer : The after-tax return required to accumulate £2 million in 18 years beginning with an investable asset base of £1,235,000 and with annual outflow of £26,000 is 4.427%, which when adjusted for 40% tax rate, results in a 7.38% pretax return [4.427%/(1-0.4) = 7.38%]. Annual Salary = £80,000 Less: Taxes (40) = £32,000 Expenses = £74,000 Net annual cash flow = -£26,000 __________________________________ Here’s my thought: The annual net cash flow is generated from the portfolio, thus it is subjected to 40%, and has to be withdrawn each year. Which means the pretax annual cash flow is £26,000/0.6 = £43,333. Since the capital gains that needed to accumulate £2,000,000 is unrealized, they are not taxable. Thus the pretax required rate of return = 5.59%. (using calculator, N=18, PV=-1,235,000, PMT = 43,333, FV = 2,000,000, CPT I/Y = 5.59) Could anyone please comment on my reasoning? Thanks!
Sounds like you are over thinking it… When they say after tax You say xx / 1-t
agree with mr.good.guy 26.000 = pmt (don´t incorporate here 1-tax) -1.235.000 = pv 2.000.000 = fv 18 = n I sort of understand your reasoning, but you are assuming that the difference between 2.000.000 and 1.235.000 is a capital gain NOT REALIZED at maturity, and nobody mentions that in the text. Actually, if that money is necessary to pay for education and whatever expenses, sounds more like spending those 2.000.000 at maturity (so the capital gain will be realized)… But again, that is an assumption, and as ws or bigwilly told me here, that is the mother of all f* ups. For the exam, I would not assume anything Hope this helps
Thanks! I also feel that I’m over thinking (getting paranoid!). The morning essay questions always have “assumptions” in the guideline answer. I still can’t see the “pattern” on how to attempt those questions. Hope luck is with me during exam…
Quick question to anyone else working on this question? Has anyone tried calculating the return requirment by GROSSING UP THEIR EXPENSES. I.E. Living Expenses = 74,000, Grossed up = 74,000/.60 = 123,333 I tried this and then deducted his a/t income of 48,000 to get his income requirement and then divide this by the asset base of 1,235,000 and add the growth component to get to the 2,000,000. It seemed to make sense to me but in the end I got a different answer. Anybody know where my logic is flawed? Thanks