So this lady, Lima, will be prepaying (50K) her children’s education costs in a year, which she will be paying this with her portfolio’s assets (250K). She earns 140 K pretax.
Then, she will retire in 25 years.
Then, one day, she will die.
So I wrote multistage : at least 2 stages : from now until retirement, then retirement, then possibly bequest / inheritance.
But this is wrong, since apparently, the prepayment of her children’s education is a change of stage.
I find this weird, since her saving habits/expenses will not change after said prepayment.
Does it warrant a change in stage from the mere fact that it is a negative liquididy event ? I am confused here. Thoughts ?
I’m no expert b/c I have been confused reading through various years’ guideline answers, but since I just took this exam this morning…
I think it warrants its own stage b/c it’s a material payment. This payment constitutes 20% to 25% of her investment portfolio.
In terms of justifying the materiality, if it weren’t for the $50K payment (starting PV of $275k on return requirement calculation), her return requirement would be 6.42%. Pretty big difference from the 7.05% required with the starting PV of $225k after the $50k payment.
Think of the time horizon as being path-dependent. Everytime there is a decision point, actual realized cash flows (in and out) and returns will have varied from the original assumptions made in the IPS.