2012 morning session Question 1

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dweitz

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In the 2012 morning session from the CFA website, in Question 1, part A, why does the required return calculation use +$25,000 for the annual PMT to rather than -$5,000 which would incorporate the $30,000 annual support to local youth sporting leagues?? Really confused as to why REQUIRED RETURN does not incorporate annual expenses. Any thoughts? Thanks.
 
I made the same mistake last year.
As part of his normal expenses, Alonso annually provides approximately USD 30,000 of support to local youth sporting leagues.
So it is part of Normal expenses - hence already included and the 25K savings are after making that expense.
 
I got this right but it was a total guess. The clue for me was that his salary and living costs (from memory) werent listed. So this was an incomplete picture of his incoming and outgoing money to start with.
 
I try to remember to focus on risks that could impact one’s required expenditures (healthcare for family members, debt, children’s education). As cold as it sounds donations to a higher cause are not deemed required in the context of this exam, and should be viewed as something that increases ones ability to bear risk.
 
this is probably a dumb question, but i can’t figure out what i’m doing wrong.
to calculate the required return i used my financial calculator. inputs: CF0 = -650,000; C01 = -25,000; F01 = 15; C02 = 1,600,000; F02 = 1; then IRR + CPT. The calculator gives me 3.3769, the answer key shows 3.65.
where am i going wrong, or did i even approach this question properly?
 
this is a typical set up for the PV, PMT, FV CPT I/Y process.
If you want to use the CF process
CFO=-650000, C01=-25000 F01=14, C02=1575000, F02=1
gives you 3.6466
(remember you paid out 25000 in year 15 and received 1600000 at the end… (same year).
 
@cpk123 thank you! i knew i was making a silly mistake. not netting the last CFs was the issue. much appreciated.
 
in this particular case it is easier to use the other function …
PV=-650000, PMT=-25000 N=15, FV=+1600000
CPT I/Y
Most of the CFA IPS questions lend themselves to this format in an easier manner, and here you do not have to remember to net out, etc. etc. (Fewer key strokes, fewer things to remember)
 
As with so many topics in the CFA curriculum, drawing a timeline is your best approach.
Timelines are your friends.
 
I made the same mistake by including it as a cashflow–have to watch out for little stuff like this on exam day.
 
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