schweser vol 1 exam 1 question 1 (Ernie Marks case) first, question, required, account, morning

manchester88

quick question
in the first question of the morning session (Ernie Marks Case) how come when they calculate the required return they don’t account for taxes. They account for taxes on Ernie’s income, but not on the return requirements of the portfolio?
Cash inflows for coming year:
$150,000
Cash outflows:
taxes on salary: $49,500
living expenses: $100,000
Allison’s Care: $105,000
Ernie Jr Stipend50,000
Net: $-154,500
Required after-tax rate of return = 154,500/5,000,000 = 3.1%
i see that the salary is taxed, but shouldn’t the other expenses be bumped up by the portfolio tax rate in order to figure out the after-tax return requirement?

PalacioHill

Only the portion of the expenses that need to be met by the portfolio need to be bumped up by the portfolio tax rate in order to figure out the after-tax return requirement.
Think of it like this: You are already taking taxes out of his salary. Expenses are first paid by his salary, then he uses his portfolio to cover the deficit. So only the portion of the expenses paid by the portfolio need to be bumped up by the portfolio tax rate.

bchadwick

da1nonly:
Note: I gave you an explanation without reading the question. After reading the question, the explanation I initially gave does NOT fit the question because they are asking for after-tax return (in other words ignore the effect of taxes on the return). My explanation would have fit if they asked for the before-tax return. Sorry!