First question…always a good sign.
Soi they calculate the real investment income that is needed to satisfy expenses as:
300,000(1.025) - 125,000(0.70) = 220,000
Fine.
Then they say the rea after-tax rate of return is 220,000 / 11,000,000 = 2.00%.
My question is, doesn’t he need to pay tax on whatever income he makes to get to 220,000?
So the before tax investment income would be: 220,000 / 0.7 = 314,286
That means the real after tax return is 314,286 / 11,000,000 = 2.86%
Then adjust for inflation and the answer is:
(1.0286)(1.025) - 1 = 5.43%
i had the same question to this question, which in my opinion was never answered. my answer actually had a higher rate bc i took the after tax value of the lump sum (10m*tax rate).
http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91342095
dwheats:
First question…always a good sign.
Soi they calculate the real investment income that is needed to satisfy expenses as:
300,000(1.025) - 125,000(0.70) = 220,000
Fine.
Then they say the rea after-tax rate of return is 220,000 / 11,000,000 = 2.00%.
My question is, doesn’t he need to pay tax on whatever income he makes to get to 220,000?
you accounted for tax on his income when you did this: 125,000(1-0.3)
So the before tax investment income would be: 220,000 / 0.7 = 314,286
This math is not necessary… you are asked to calculate the after tax return… you already know, net of all taxes you need 220,000.
That means the real after tax return is 314,286 / 11,000,000 = 2.86%
No, this means his real PRE-TAX return is 2.86%, but you didn’t need to calculate this to begin with.
Then adjust for inflation and the answer is:
(1.0286)(1.025) - 1 = 5.43%
You calculated the nominal PRE-Tax return in this calculation. Substitute the 1.0286 with 1.02 and you get 4.55%, the correct answer, the nominal after tax return requirement.
See my responses in bold, above.
FYI - this is not the 2014 AM Mock… the is the REAL 2013 AM Exam.