Quick question - IPS and Inflation

CFA Level III
#1

If you are required to calculate pre-tax return, do you add inflation before or after you perform the return/1-tax rate? Thanks

#2

add inflation before you perform the return / 1-T calculation.

#3

I would do before. also when you have a net outflow from portfolio, and we have the inflation rate, do we always input the PMT as today cashflow*(1+inflation)?

#4

i haven’t seen any questions like this, but what is the rationale of adding the inflation number before the tax calculation? i probably would have done it after, but haven’t thought about it enough. thanks.

#5

there is an example in schweser videos - I think I got it now first - they talk about long term return requirements - they use pmt adjusted for next years inflation ( expected to stay stable for the whole period) second when asked about NEXT year return, they dont adjust for inflation

#6

this was the ingrams

#7

yeah, i reworked the ingrams ips problem yesterday. in that case though, everything was done pre-tax. and inflation was added at the end. AFTER you got the pretax number, no?

#8

sorry florin, i guess you were referring to your own question…

#9

for the long term return - they inflated next year payment - they calculated the return and then added inflation

#10

but to the original question posted by maagian. in the ingram’s case, they add inflation after they’ve already got the pretax return.

#11

cfasf1 - the rationale - since that is your question would be that inflation is taxed as well if I make 100k in nominal terms - that is what I get taxed on, I don’t get taxed on 90k because 10% was inflation

#12

Ok, so in other words, add inflation first, then calculate before tax nominal return. Thanks

#13

had to get out of the house. somehow, this is my fault, this thread got confusing. i’m not actually sure that florin and i are even disagreeing. at the risk of making it more confusing. say you have an after tax required return, that has not included an inflation component. say 4% is the after tax requirement. tax rate is 20%. so your pretax return requirement is 5%. if inflation is 2%, you are saying you would go, (4%+ 2%)/.8 = 7.5%? and i would go, 4%/.8 = 5% then add 2% inflation to get 7%. is this what we are saying?

#14

yes I would do first one

#15

upon thinking about this some more, i think you are right, florin. thanks. i guess i was thrown off by the ingram case. in that case, didn’t they get the pretax retun then add the inflation rate on top of it?

#16

wow. sorry florinpop. you are absolutely right. i’m not sure what i was thinking. you added the inflation to the pretax return so it could be taxed. there is nothing to be confused about with the ingram case. sorry for causing the confusion. i think i’ve hit my limit… going into the gips ethics meditative state. good luck on the test…