Reading 12 - CFAI EOC - Question 17

I am trying to understand the calculations involved in the PV calcs for Capital needs. In the question it gives us family living expenses and states that it will decline by 30,000 per year. However, in the answer this detail in not included in teh PV or mentioned in any way. Am i supposed to somehow assume that it is already included in Olivia’s and the children’s living expenses? If anyone could explain the logic here it would be greatly appreciated.

These questions are included on the webpage as a supplement since they weren’t included in the books themselves.

The logic must be that the “Cash Needs” in Exhibit 1 are used to close out the “Family” expenses. But, then why would they put a bullet point about Family expenses declining by 30,000 per year if Adrian dies? This seems to imply that we should factor a PV of the declining expense as separate from the Cash Needs… This question seems to me to be very misleading and a potential trap.

Can anyone please brief up on this? I am stuck on the exact same thing.

The 30k decline is reflected in the reduction on expenses from the mom and the kids. Its already done for you in the very next sentence.

Bringing this back from the dead. We used real discount rate to compute for the PVs?

bump. why did we remove the growth factor in the discount rate? i assume the growth factor is the inflation.

Yes. Numerator is real so even denominator needs to be real.

What do you mean ?

How’d we know that the income and expenses figure were in real terms? Like where in the case it says numbers were in real terms.

One week to go and this still confuses me. Please help

The living expenses increase by the rate of inflation every period.


Why does the text mention the $30,000 reduction in living expenses?

If Adrian is still alive => family living expenses is A$95k per year

If Adrian passed away => the family expenses will reduce by A$30k to A$65k per year (of which $50k is for Olivia and $15k for the children).

It’s additional information in this case, since they gave the projections separately for Olivia and the children.

If they did not split the family expenses and said that family expenses will be $65k for 25 years (for example), then you will use that info for calculation.