This is question #6 on 2013 AM Mock.
Some details provided are as follows:
- New university foundation created with initial value of 100 million
- 3 million is given out at the start of year 1 from the foundation
- starting in year 2, the foundation will recieve 2 million at the start of the year
- Starting in year 2, the spending requirement will be 6% of the preceding year portfolio value.
- Inflation rate is 3.5% for the university
- Investment advisor is hired with management fees of 0.4% per year based on the year end value of the portfolio, paid on first day of the following year
What is the return requirement for year 2?
The CFA answer: 6% + 0.4% + 3.5% (or multiplicative works as well)
Can someone explain why you wouldn’t calculate an exact return requirement? Do you always just add up the spending rate and fees and inflation?
For example what I did:
100 milion - 3 million given out = 97 million left at the end of the year 1
Required distribution = .06(97 million) = 5.82 million - 2million (recieved at start of year 2)Total = 3.82 million
Required return = (distribution/year 2 starting value) + inflation + management fee = (3.82/97) + 0.035 + 0.004 = 7.83%
Although in the question, the return earned during the first year wasn’t specified, so the starting year 2 value is probably not accurate. I was kinda confused about this one.