Reading 10 Ex11 question

[pablosdad]

For the calculation of Account B, I know this is not right, but I can’t pinpoint why my way is wrong.
I did the following:
FVIF = €3,000 [(1 + 0.06)30(1 – 0.25) + 0.25] = €13673 – I’m thinking of Equation (2b)
[ The answer is:
FVIF = €4,000[(1 + 0.06)30(1 – 0.25)] = €17,230 ]
Thanks for explaning in advance!

 

[ink]

you have two mistakes that relate to the present value of the investment and the cost basis.
First, the present value is 4000 because the problem specifies that value. Mims either has the choice of investing 3000 on an after-tax basis in a tax exempt account or 4000 on a pre-tax basis in a tax-deffered account. In other words, read the question carefully when you input the information: “A tax deferred account, where Mims can make a €4,000 tax deductible contribution…”
Second issue is that you have not considered the cost basis correctly. In your wrong solution, you put B=1, meaning that, the initial contribution should not be taxed at withdrawal. The reality, however, is that the cost basis is 0, and you will have to pay 25% tax on the full contribution.
See equation (3a). That’s the one you’re supposed to use.