Can someone please explain to me why the answer to 2009AM Question 1 part A section ii in the return requirement grosses up the net expense need for taxes? The correct answer calculation is $45,000/(1-.2) = $56,250 which is net expense need divided by 1 minus tax rate. Then they take this figure divided by the portfolio value of $1M to get 5.625% requirement, add inflation of 4.0% to get 9.625% required return.
What I did was take the $45k, divided by $1M to get 4.5% return, plus 4.0% inflation = 8.5%, divided by 1-tax rate of 20% = 10.625% required return.
Can someone please explain why I am wrong here?
This has been discussed before, look in Schweser, the CFAI used two methods for this type of question.
Case in point, if inflation is taxable, then you are correct, if it is not, then the answer key is correct. They changed it afterwards, you’re answer should get full credit today.
It would be nice if someone else can agree to this.
I will look to review the two methods mentioned in schweser. I don’t see how the answer key could be correct in this case as there is nothing indicating that the inflation in the portfolio would not be taxed.
Thanks for response, I agree that if someone else would confirm Mr. Smart’s answer that would be comforting.
I am about to post a barrage of these types of questions as I’m going through the 2009 mock this morning (cheers to slow work days).