Schwesers book 1 I was going through the concept checkers for session 4 -book 1 page 231. Question 7 C. While calculating the RR for DuBois, the statement after the 4.36% calculation is the source of cofusion. I calculated the 4. 36% return requirement correctly but then, why add 3 % for inflation again when it’s already accounted for in the first line ? 60000 + 30000 * 1.03 = 92700 already accounted for in this claculation. How do you get 7.36% ? Any input is appreciated.
I don’t have the book in front of me, but I think I remember this. You only accounted for one year of inflation. Multiplying this year’s expenses by 1.03 gives next year’s expenses. 4.36% is the required real return. You add the 3% inflation premium because inflation will continue every year.
If you count today’s dollars, the cash needed for liquidity is 90,000 after -tax, which makes it 125000 before tax. The required return then comes out to be 4.24 % ?!!!
Hi, I agree with joemontana re the inflation. BUT, I have a problem with the way the before tax return is computed. Assuming that returns necessary to cover inflation (3%) are also subject to taxes, I think that the before tax return has to be 4.36% + 3% / (1-0.28) = 4.36% + 4.17% = 8.52% If the required return to cover inflation is just added to 4.36%, it is assumed to be a tax-free-return. Any input is highly appreciated!! Regards, Daniel