leonardus

brafique
You must draw a line between Required needs and Desired needs. The required ones determine the required rate of return.
Next step is to look at whether money are in real terms or nominal terms.
Your problem indicates that John Smith doesnot know what real money are meant to be - hence, he’s considering in nominal terms and his portfolio is also expressed in nominal terms.
Year 0. Required needs: (50,000 + 20,000) x 1.02 = 71,400 at the beginning of Year 1.
Required return (real) = 74,400/5,000,000 = 1.428%
Year 1. Nominal required return: 1.428 x 1.02 = 3.457%
Correct me please if i made a mistake.