In question 1A it asks for nominal after-tax required return for the coming year. You gross up last year’s expenses for inflation reflecting this year’s expenses, but then you add inflation again to the required return which you’ve calculated. Why do you need to account for inflation twice in one year? Should you always apply inflation to the expenses and the return required?
expenses grow at inflation.
also states portfolio needs to maintain purchasing power (i.e. inflation)
I agree with your statement however the question states “Determin the Voorts’ nominal after-tax required rate of return for the coming year.”
Therefore I think the answer is incorrect in adding another layer of inflation after you calculate the real, after tax return since we have already adjusted for inflation for this coming year by adjusting expenses upwards by 2.5%.
Can someone please explain if they disagree with the above?
Sunman is right. If a question says that a goal is to maintain purchasing power of the portfolio, inflation must be added (or multiplied, if geometrically computed) to the real return of the portfolio. The fact that outlfows (or inflows, for that matter) grow with inflation is unrelated maintaining purchasing power of the portfolio.
As an example, if the question says expenses grew by the rate of GDP growth (instead of inflation), you would factor this adjustment when comouting the real return of the portfolio. Then, the inflation rate is added to reach the nominal return. The distinction is that inflation related to inflows and outflows does not have any bearing on maintaining the purchasing power of the portfolios principal.