Came across this a couple times and am wondering the correct way to account for inflation when you are asked to calculate a pre-tax required return and given after tax needs. So lets say a guy has a million dollar portfolio, needs 100k per year plus 2% inflation and taxes are 25%.
Do you:
(100/(1-.25))/1m + 2%
or
((100/1m)+2%)/(1-.25)
I would think the first way but one of the Schweser practice exams did it the second way so maybe i’m missing something.
(Need/Base) + inflation / (1-Tax rate) is what I think is the way to do it.
So, 10% + 2% / (1-0.25) = 16% required return.
I am still tripping up over required return, so don’t take my answer as final. I’m hoping someone more qualified approves my calculation so that both of us could learn something!
Why do we have multiple threads on this very question every year?
_ Every year! _
Here’s how you do it: http://finexamhelp123.wpengine.com/inflation-in-required-rate-of-return-to-tax-or-not-to-tax/
Because we know people like you will point us in the right direction!
Aaawww.
Unless you have a clear indication in the vignette that inflation “returns” can be shielded from inflation, you cannot really go with the first equation, as that would imply the effects of inflation are tax deductible.
The point is that you do have a clear indication in the vignette when inflation returns are shielded from taxation, and when they are not. CFA Institute is quite clear on that point, and in the article I wrote I cite examples going back 14 years.