IPS problem ?

Hi, Consider the following example from Schweser notes. ‘The client is currently 61 years old and wants his portfolio of $102 million to reach $200 million by the time he is 75 (a time horizon of 14 years). He also wants to give $1 million to charities every year, adjusted for inflation. The long term inflation rate is 1%.’ Ignoring the annual distributions, the portfolio needs to grow at 5% annually. However I am not sure how to adjust for the inflation adjusted $1 million distributions annually. The book ignores inflation of 1% and assumes 1% of annual distributions per year. I am not happy with that solution. Is there a better way of solving this problem? Thanks, MG.

I am extremely unimpressed with the return requirement LOS. I am not convinced that this section adds any value. The entire point seems to be to arbitrarily assign numbers to unmeasurable and unpredictable quantities. None of the situations in the problems seem to me to be real life examples. The entire thing seems to be mumbo jumbo and smoke and mirrors just to impress clients by saying “here, we’ve crunched the numbers and determined that your ‘return requirement’ for the next 25 years is exactly x.xx%.” I just don’t think business works like this, and the real world certainly doesn’t, since circumstances change constantly and objectives and desires are subjective and flexible. /Rant over. Sorry I realize that this did not help answer your question./

didn’t they add the 1% inflation to the 5% to arrive at 6%. I think I remember this problem. Also the 1% outflow as PMT for the TVM calculation is accurate = 1.01/102 Dwight, till the exam put the real world complexity aside - 16 days to go!!

Good advice…

I assume they perform all calculations in real terms and then make a conversion to nominal terms.

<< heer said: didn’t they add the 1% inflation to the 5% to arrive at 6%. I think I remember this problem. >> That 1% is related to the annual distributions of $1mil. <> The $1 million distribution would not be 1% of the pf value when portfolio has reached to, say, $150 milllion.

yes so the PMT will only take the next years value as say $1.01 million and then at the end account for the inflation of 1% by adding the 1% to the I/Y, I just ran the calculations on my calc, I don’t get 5% :frowning: :frowning: N = 14 PMT = -1 or -1.01 FV = -200 PV = 102 Any other info I am missing?

The 5% is obtained by solving (200/102)^1/14 -1 Also, as far as I know, the PMT value is a constant payment. Technically, therefore, you can’t use first year’s distribution.

I agree with heer, by simpling doing: N = 14 PMT = -1 FV = 200 PV = -102 CPT -> Y/I Then add 1% (sum or compound) to the resulting Y/I. It looks straightforward, am I missing anything?

using cash flow cf0=-102, cf1=1, cf2=1*1.01, cf2=1*1.01^2, cf3…, cf14=200+1.01^13 irr= 5.7 is it right?

Its perfectly valid to ignore the inflation in the amount of the distribution because the distribution represents less than 1% of the portfolio and the inflation rate is 1%. By the time hes 75 the nominal value of the distribution is $1,149,474 against $1,000,000 on a c. $200m portfolio. Thats a difference of 7bp of the total return