If a private foundation has assets of $4M and it is providing tuition ($200,000) which increases at an annual rate of 4% over the long-term. The inflation rate is expected to be 2% for the foreseeable future. Shall we incorporate the inflation rate (2%) into our calculation of return objective as : (1+$200,000/$4,000,000) x (1+4%) x (1+2%) ? Or the increases at an annual rate of 4% of the tuition has already incorporated the inflation rate (2%) in it and our calculation of return objective is just as : (1+$200,000/$4,000,000) x (1+4%) ? Anyone can clarify ?
text not clear whether tuition increases is on nominal or real basis, so can’t make clear conclusion.
elcfa Wrote: ------------------------------------------------------- > text not clear whether tuition increases is on > nominal or real basis, so can’t make clear > conclusion. Ya, I am confused by this ! But I think the increases at an annual rate of 4% of the tuition has already incorporated the inflation rate in it.
Is this a real q? It will help if you can post the source.
AMC Wrote: ------------------------------------------------------- > If a private foundation has assets of $4M and it > is providing tuition ($200,000) which increases at > an annual rate of 4% over the long-term. The > inflation rate is expected to be 2% for the > foreseeable future. This is a increase in tution fees. 200,000(1.04) for the first year assuming inflation is covered by 4% or add inflation to it 200,000(1.06) If they ask return req for 5th year…just compound tution fees accordingly. In the absence of information we need to calculate return requirement for the first year. 208,000/4m = 5.2% +inflation 2% ( to protect the purchasing power of portfolio) Total= 7.2% We can use multiplication rule.
derswap07 Wrote: ------------------------------------------------------- > Is this a real q? It will help if you can post the > source. It is in Q-bk.
The solution to this q is : (1+$200,000/$4,000,000) x (1+4%)
perfect example that on the exam, u will see useless info. in this case, the 2% annual inflation is the useless info. since 4% is the applicable inflation to this foundation
guys have a look at ‘‘morning exam 1 practice exam Vol1’’. Question #1 says indivisulal investor had an annual medical expense(for daughter) of $100,000 last year which will increase by 5% annually. Expected inflation is 2%. Requires return is calculated as 100,000 * 1.05 / Portfolio value = X %. Req return = X % + 2%. I am confused how to account for annual increase in expense.
hs_1811, If the Portfolio (assets) value is $4M in your case and if we follow the rule in my above-mentioned example, then : Req return = (1+100k/4M) x (1+5%) -1 = 7.625% I think if the future expense is expected to increase at a fixed rate, it shall mean that the inflation rate is incorporated in the increasing rate of the expense but the increasing rate of the expense shall be greater than the inflation rate. Anyone else can comment ? Ask CFAI to clarify ?
hs_1811 Wrote: ------------------------------------------------------- > guys have a look at ‘‘morning exam 1 practice exam > Vol1’’. Question #1 says indivisulal investor had > an annual medical expense(for daughter) of > $100,000 last year which will increase by 5% > annually. Expected inflation is 2%. > Requires return is calculated as > > 100,000 * 1.05 / Portfolio value = X %. > > Req return = X % + 2%. > > I am confused how to account for annual increase > in expense. I think in this question, they mention it that for the daughter’s expenses, the relevant inflation is 5%. I have noticed that particularly in the endowment q, the tuition’s rate of inflation is different. So we have to be VERY careful when calculating the RR.