Grossing up expenses by the tax to me is weird, I know Schweser uses this as 1 of the 2 ways to do it, but weird.
if inflation is asked it is always the last thing to add. see page 190 of book 2 exhibit 8 and question 12c with answer on page 228.
so gross up to pretax than add inflation.
[(1+r)/(1-tax)] * [1 + Infl] - 1
or just add inflation, because it is only one period.
Good analysis. Do you also track what Institutional was aksed in the past exam. I have come to that point where I need to game this exam … lol
Here:
CFAI book 2, page 177, last paragraph before Exhibit 5:
“Note, strickly speaking, the inflation rate should be adjusted upward by the portfolio’s average tax rate.”
CFAI book 2, page 193, last paragraph at the bottom:
“Her (Ms. Fairfax) 3% real, after-tax return…implies a gross total return requirement of ast least 10.8%, assuming her investments are fully taxable and assuming a 4% inflation.”
[quote=“cpk123”]
HM
Can you show me a location in the book where they do this
[Quote]
They are inconsistent in the Susan Fairfax case.
3% after tax return, 4% inflation, 35% tax rate
should become
(1.03 * 1.04 - 1)/(1-0.65) = 10.95%
Additionally the fact that they state “Strictly speaking” and go ahead and do it precisely the opposite way for ease of presentation - both ways will be accepted.
lets just hope this inflation tax thing will not show up on exam. I am lost in this.
…
Here is a clear example of inconsistency.
2009 Exam Q1: The answer takes the required return of 45,000 and divides by 1-t, and then adds inflation of 4%
CFAI Vollume 6 Page 110: The answer adds inflation of 2%, then divides by 1-t. The ineresting thing about this question is that it was question 9B on the 2003 exam, and in the exam answer key they actually divide by taxes first, then add inflation. They changed it when they put it into the curriculum.
iteracom: It does matter which way you do it because you get differnt answers. For example:
2009 Exam Q1 method 1:[45,000 / (1-.3)] / 1,000,000 = 5.625% + 4% = 9.625%
2009 Exam Q1 method 2: 45,000 / 1,000,000 = 4.5% + 4% = 8.5% and 8.5% / (1-.3) = 12.14%
so what do we do if asked on exam?
.
doesnt what get adjusted?
I’d only point out that the 2009 test offers one differenting subtlety (which I missed), which states that taxes are due on withdrawal.
Otherwise, to me the most consistent approach is to gross up tax by inflation. If I’m going to get it wrong, I’d rather be faulty in this direction.
i dont think it matters that taxes are due on withdrawal. youre still taxed every year and adjust for inflation every year. i think the 2009 way is more conceptually correct anyway.
has anyone emaild CFAI about this? seems ridiculous that they cant be asked?
I think the answer given in 2009 in Tracy’s is incorrect
if the pretax return is 9.63%, after tax should be 9.63*0.8=7.7%
minus inflation, the real return is actually 3.7%. Don’t meet the 4.5% required real return.
I think the answer given in 2009 in Tracy’s is incorrect
if the pretax return is 9.63%, after tax should be 9.63*0.8=7.7%
minus inflation, the real return is actually 3.7%. Don’t meet the 4.5% required real return.
The cross-products were ignored in the example. Hence, 3% + 4% = 7%/65% = 10.76% or 10.8%
[quote=“cpk123”]
They are inconsistent in the Susan Fairfax case.
3% after tax return, 4% inflation, 35% tax rate
should become
(1.03 * 1.04 - 1)/(1-0.65) = 10.95%
[quote]
I think CFAI will accept both ways. And if we really blew this last little part, maybe we lose 2 points.
Hey guys, I looked at CFAI L3 books from 2011, and it’s the same exact example that is used as well where they did inflation first, then tax effect. So, this isn’t some “new” development for 2012.
Does anyone have the CFAI L3 books for 2009? maybe we can confirm something there, since the question we’re all confused about is from the 2009 AM .
I emailed to CFAI for this problem but they said “The CFA Program is designed for independent self-study. We cannot tell you how to interpret specific readings or advise you on how to answer exam questions.”
However, I also see on the page 110 CFAI vol 6 , the calculation nominal before-tax return for Campell as following:
“The living expenses, estimated at 78kper year, represent a 78k/3mn = 2.6% spending rate in real, after-tax terms. However, because the Trust is taxed at 30%, it will need to earn a pretax return of (2.6%+2%)/(1-0.3) = 6.57% to meet Javier and Campbell’s living expenses.”
I choose the way add inflation to real after-tax return then gross up.