PM question - inflation

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passcfa2016

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If you are given that current income is fixed at say $10,000 and current expenses are $8,000 a year and expected to increase at 10% a year. You are required to compute the rate of return. Should one compute the CF1 as follows:
(10,000 - 8,000) x 1.1 = 2,200
OR
(10,000 - 8,800 x 1.1) = 1,200
Slightly confused????
 
I believe the rate of return required in this case to be -2000/portfolio + 10%
 
You want the shortfall, not the net inflow.
Option 2 applies inflation in the current year, not subsequent ones.
The forumla I used above should give you the return requirement to cover expenses in perpetuity.
 
MrSmart wrote:
You want the shortfall, not the net inflow.
Option 2 applies inflation in the current year, not subsequent ones.
The forumla I used above should give you the return requirement to cover expenses in perpetuity.
Click to expand...
Thanks Mr Smart but i still dont get it…..Can you explain in a more clear way???
 
I think I might be wrong on all this. There is no linear relationship because of that fixed variable. it distorts the timeline of growth too much before reaching a steady state.
I tried $5,000 income fixed and $8,000 expenses that grows 10% a year with a portfolio value of $100,000.
The required rate of return should have been 3%+10% = 13%. But after running an excel simulation, the number is actually 16.79% to keep prinicpal from drying up over a long period of time. There’s a logarithmic relationship that could be applied here, beyond my scope, and the material.
8% is also wrong using your example, the actual number is much higher, if the client wishes to preserve principal. Maybe someone else can chime in.
Edit: If you were just asking about CF1 (by this year end), then do not include inflation if the amount is a current expense. If the expenses were incurred last year for that amount, you may grow it with inflation for this year.
 
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