Hey guys,
Could anyone shed some light on q13 part A ii) where you need to formulate a return objective. It all makes sense up to the return calculation, I can’t quite figure out how they got 4.427% after tax.
I may be missing something really obvious but any help would be much appreciated.
Thanks!
Income : 80000
Tax = 40% of 80000 = 32000
Living Expenses = 74000
Net outflow = 48,000 - 74,000 = (26,000)
====
Assets:
Inheritance: 900,000 + Assets (5000+160,000+220000) - Down Payment (30,000) - Donation (20,000) = 1235000
Need 2000000 in 18 years.
PV = 1235000 (positive inflow)
FV = -2000000 (outflow, negative)
PMT = -26000 (outflow, negative)
N = 18
Compute I/Y = 4.427%
Add up assets = 1, 285,000
take off liquidity requiremennts 30,000 + 50,000 = 80,000
Investible assets = 1,235,000
requirent or fv in 18 years = 2,000,000
Here is the catch…due to salary and living costs they are net spenders, so actually draw 26,000 from the pf each year…
So when you work out the FV calc for 2,000,000 in 18 yrs…you need to consider that from the pv of 1,235,000 there is actually a payment OUT of the pf of 26,000
pv = -1,235,000
fv = 2,000,000
n = 18
pmt = 26000 (note sign as payment out, not into pf)
cpt i/y = 4,4274
Thanks for the rundown, both of you!
I was messing up on the sign of the PMT, will be sure to look out for that in future.
Hello ! Quick question about the same problem : why don’t we take inflation into account? The 26k net annual cash flow will increase with inflation. For instance, if inflation is 100%, next year, the needed cash flow will be 160k x 0.6 - 148k = 52k, not 26k …
I understand however that the 2m, unlike the 26k, are given in nominal terms.
Thanks a lot everyone !
Which question in which reading is it now?
It is still reading 10, question 13. Thanks much !!!
Because nothing in the vignette tells us to take inflation into account.
If CFA Institute wants you to include an inflation component in the calculated return, they’ll say so. For example, they could say that the Maclins want to maintain the real value of their portfolio, or want to maintain purchasing power, or they could ask you to calculate a nominal required return. But if they don’t tell you to include inflation, don’t include inflation.
Thank you much S2000magician, I understand that, we would assume that inflation is 0% if no more info is given ; however, the problem states in its solutions that “No inflation adjustment is required in the return calculation because increases in living expenses will be offset in Christopher’s salary”, which would be right if the after-tax salary (48k) was equal or greater than living expenses (74k).
It is the explanation given that does not make make sense since the solution mentions inflation and implies that the Maclins won’t have to worry about inflation, not because it is nonexistent/unsignificant, but because the salary increases with inflation : whether it does or not, there is a deficit between after-tax salary and living expenses that will increase over time, less, I recognize, that if the salary was fixed and not indexed to inflation.