PWM: after-tax vs. pre-tax returns

One thing that keeps on confusing me is the distinction of after-tax and pre-tax returns in PWM. As far as I understand it, you usually sum up all regular cash outflows, eg. living expenses, which are after-tax. In order to compute pre-tax returns, you have to calculate the required return on the asset base, which is usually pre-tax (especially in case of low basis stock). For example, page 148 in CFAI books, example 11 (Mueller case): Asset base of 550’000 (after subtracting immediate college expenses); this is pre-tax, tax rate on gains is 30%, unrealized losses of 50’000 Cash outflow per year of 15’000 (income - expenses - tuition costs). In the solutions on page A-9, return is computed as 2.7% = 15’000 / 550’000 However, I dont understand how they can compare the pre-tax asset base to after-tax cash flows. Any ideas? Thanks, OA

Depends if they are asking you to find the after-tax return requirements or the pre-tax return requirements. In the problem above, if the 16K is a after-tax number than that would be the after-tax return requirment.

Thanks. I think I totally got the problem wrong above, so forget the numbers. So, if I understand you correctly: If I have 15K after tax cash flow requirements and an asset base of 600K, you would calculate after tax required return as 15/600? So how is before tax calculated? E.g. in the example, gains tax is 30%, income tax is 20%. 1/3 of the 500K is low basis stock. Further, there is a tax cushion of 100K in unrealized losses. How would you calculate the pre tax return in this case? Thanks, OA

old_akakaraka Wrote: ------------------------------------------------------- > Thanks. I think I totally got the problem wrong > above, so forget the numbers. > > So, if I understand you correctly: > > If I have 15K after tax cash flow requirements and > an asset base of 600K, you would calculate after > tax required return as 15/600? Yeah, I think so. So how is before > tax calculated? E.g. in the example, gains tax is > 30%, income tax is 20%. 1/3 of the 500K is low > basis stock. Not sure here. I have to think about this one. Further, there is a tax cushion of > 100K in unrealized losses. How would you calculate > the pre tax return in this case > > Thanks, OA