2007 AM Q1

[AMC]

I can not understand why the living expenses shall be inflation adjusted to be 205,500.
All other figures in calculating the “Real” Required Return are the present values.
If living expenses shall be inflation adjusted to be 205,500.-, then shall the present value of asset base of 4,000,000.- & Required Terminal Value of Asset Base of 3,000,000.- (real dollars) be inflation adjusted for 1 year ? i.e., 4,000,000.- x1.025 & 3,000,000.- x1.025 ?
Anyone can explain/clarify ?

 

[a_thinking_ape]

this was discussed in a forum 2 weeks ago. It wasn’t explained effectively then. Good luck

 

[AMC]

a_thinking_ape Wrote:
——————————————————-
> this was discussed in a forum 2 weeks ago. It
> wasn’t explained effectively then. Good luck
TKVM for your advice. But if no one can understand CFAI’s guideline answer, what should we do ?
I think it is very vague about the calculation of return objective both in CFAI’s readings & its guideline answers to old exams.
However, questions of calculation of return objective appear on the exam every year !

 

[Eastview]

There will be 200,000 payout “immediately”. That will be part of liquidity need. So the next relevent cash payout is a year from now, which is 200,000 adjusted for one year worth of inflation.

 

[vtw]

I did the math in a spreadsheet and the CFAI got it WRONG on the 2007 Exam guideline answers.
The CFAI may be inconsistent, however there is only one right answer in the math.
You have to set the first payment to be in today’s value of $200,000, not $205,000. (If all numbers are entered in their present value, then the IRR is in real terms and must be adjusted for inflation.) Doing this gives a real IRR of 4.7058984…%, and therefore the nominal return is (1.047058984…)(1.025) - 1 = roughly 7.323546…%.
When you let the $4m grow at that rate and let the payments start in year 1 at $205k and grow at 2.5% per year with a final payment of $7,594,257 ( = 3,000,000(1.025)^35 + 200,000(1.025)^35 ), you get a final balance of $0 as needed.