Hi everyone.
I am confused when it comes to required return calculation when constructing IPS.
When we calculate required return in the first year of retirement (example below), when exactly living expenses occur ? Logically, retired person should have cash at the beggining of the year. In question 2 AM 2011 exam we are told that inheritance will be transfered to Becker “at the end of this year”->ergo at the beggining of the next year. So, if the living expenses amount should be in disposition of retiree at the beggining of next year, our investable base haven’t got time to generete any return yet.
Is there any general rule one should assume with cash flow timing in IPS required return calculation ?
Below the question I am confused with (sorry for lack of formating):
"Five years have passed. Robert Becker recently died and left his estate to his only child,
Michael. Michael and his wife are both 50 years old and have no children. Michael expects to receive his after-tax inheritance of 8.0 million U.S. dollars (USD) at the end of this year. The Beckers both plan to retire at that time, and are meeting with Emily Frost to help them establish an investment plan. The Beckers currently do not have an investment portfolio and they own a home valued at USD 3.7 million. At the end of this year, the Beckers’ outstanding debt will be USD 3.5 million (home mortgage) and USD 150,000 (consumer debts). The Beckers will pay off their mortgage and their consumer debts soon after the inheritance is received. The Beckers currently have a combined after-tax salary of USD 475,000, current-year living expenses of USD 250,000, plus annual mortgage payments (principal + interest) of USD 225,000. Michael’s company pension will pay him USD 48,000 after-tax next year, and then payments will grow at the rate of inflation, which is expected to be 3% annually. His employer will continue to pay all of the Beckers’ medical costs until death. Both the pension and health benefits will continue to accrue to Becker’s wife, if he dies first. The Beckers expect their living expenses will also continue to grow at the rate of inflation until one of them dies. At that time, they expect the survivor’s living expenses will decrease to 75% of their combined expenses, and then continue to grow at the rate of inflation. The Beckers intend to fund their living expenses with Michael’s pension and investment income generated from their investable assets, which do not include their home. The Beckers consider their investment base to be large, and want their portfolio to be invested conservatively. They want to maintain the real value of their investable assets over time, and plan to leave their estate to charity. All income and realized capital gains are taxed at 20%."