CFA AM Q1 2013

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Cook2014

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In Section A they ask for the After tax Rate of Return.
The guideline answers say it’s 4,5%.
As the wrote that the tax on investment returns is 30%, in my opinion the 4,5% should be divided by (1-0,3) to get the AFTER tax rate. But they didn’t???
In Section D they adjust the after tax rate to get the before tax rate what I think is the right way.
Can someone tell me where my mistake is?
 
To get the 4.5% you would have already adjusted the income by taxes so no need to adjust again…in part d they are careful to note that the returns there are pre tax returns and so there you would need to adjust for taxes
 
To get the 4.5% you would have already adjusted the income by taxes so no need to adjust again…in part d they are careful to note that the returns there are pre tax returns and so there you would need to adjust for taxes
 
To get the 4.5% you would have already adjusted the income by taxes so no need to adjust again…in part d they are careful to note that the returns there are pre tax returns and so there you would need to adjust for taxes
 
To get the 4.5% you would have already adjusted the income by taxes so no need to adjust again…in part d they are careful to note that the returns there are pre tax returns and so there you would need to adjust for taxes
 
You adjust the retirement payments of 125,000 USD for taxes, that’s clear.
So you need 220,000 USD Cash.
Asset base 11,000,000 * 2% = 220,000 USD. That’s for me the investment income without taxes. As you have to pay taxes on investment income, why we don’t pay taxes here? In my eyes, you have to pay taxes for your ordinary income as well as for your investment income.
 
Its not income, it is expense , hence you require after tax investment income of USD 220000, hence the return calculated is after tax.
 
If you need an after tax investment income of 220,000 USD, you need an higher return rate than 2%, as you pay taxes on your investment income.
If you earn 2% on 11,000,000 that’s are the 220,000 USD Investment Income without taxes and on this return you should pay investment return taxes.
 
See in your example you need USD 220,000 for meeting your expense, hence you need this as after tax, if you want to calculate before tax, then you need = USD 220,000/ (1-0.30)= USD 314,286 of pre tax income.
Now Real Pretax return =USD 314,286/ USD 11,000,000 =2.86% , hence real after tax return = 2.86 (1-0.30)= 2 %.
Nominal After Tax return=2% +2.5%= 4.5 %.
Hope this makes thing clear. Just remember, they are asking you that expense (excluding your taxes)=USD 220,000. Now you can calculate what should be you your pre-tax income to meet these expenses.Which I have shown above.
 
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