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Ch 2.docx

9 Pages
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Department
Finance
Course Code
FIN 612
Professor
Coleen Clark

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Chapter 2: Factors Affecting Retirement Planning 1. What is longevity? Why does it matter in the retirement planning process? (pg 56)  Longevity - retirees need to plan for life to avoid outliving assets o women have longer expectancy than men = greater risk not having enough to live on in retirement o ppl live longer b/c: • better health care system • advances in medical tech • better nutrition • emphasis on exercise 2. What is the probability of: (pg 56) a) a 60 yr old man living to age 85? o 31% b) a 65 yr old man living to age 85? Note: These answers are different because some men die between the ages of 60 to 65. To reach the age of 85, a 60 yr old man must 1st live to age 65. o 33% c) a 60 yr old woman living to age 80? o 69% d) a 65 yr old woman living to age 80? o 71% 3. What is the value in 30 yrs of $50,000 in 2008 dollars, if inflation is 2.5%? What is the amount in 30 yrs of $50,000 in $2038 if inflation is 2.5%?  Value = 50,000  Amount = FV = ? = 104,878.379 o n = 30 o PV = 50,000 o I% = 2.5% Chapter 2: Factors Affecting Retirement Planning 4. Jill will be receiving a pension at retirement of $35,000 a yr. She expects to live to collect this pension for 30 yrs. The nominal discount rate is 7% and the inflation is expected to be 2%. a) What is the real discount rate? o k real(1 + nominal rate/ 1 + inflation rate) - 1 = (1.07/1.02) -1 = 4.902% b) What is the PV at retirement of her pension if it is: i. Indexed = w/ real interest rate? • n = 30 • I% = 4.902% • PMT = 35000 • PV =? = 570,772.9413 • BGN mode ii. Not indexed = w/ nominal rate? • n = 30 • I% = 7% • PMT = 35000 • PV = ? = 464,718.59 • BGN mode 5. What is bracket creep?  no inflation adj to tax brackets --> average and marginal tax rates increase  tax brackets go up by more than inflation  salary increases due to inflation, their average and marginal tax rates will both gradually "creep up"  impact: gradual impairment of one's purchasing power due to increased tax bill  not occur if govt increase the tax rates by, at least, the rate of inflation 6. Alice earned 9.2% on her RRSP investments this yr and inflation was 3.5%. Her investments are worth $150,000 and she wants to retire in 12 yrs. Chapter 2: Factors Affecting Retirement Planning a) What is the future value of her investment at the nominal rate of return? o n = 12 o I% = 9.2% o PV = 150,000 o FV =? = 431,283.5757 b) What is the future value of her investments at the real rate of return? o real rate = (1 + nom/ 1 + inflation) -1 = (1.092/1.035) - 1 = 5.507 = I% o n = 12 o PV = 150,000 o FV =? = 285,416.255 c) What is the value of part (b) if you add inflation back into the future value? o Val = 431,283.5757 b/c nominal not include inflation 7. Marshall's Guaranteed Investment Certificate is earning 3% before tax and his marginal tax rate is 44%. (pg 64) a) What is his after tax rate of return? o After tax rate of return = (I%)(1 -T) = (0.03)(1 - 0.44) = 1.68% b) If inflation is 2%, what is his real rate of return: i. before tax? • real rate = (1 + nom/ 1 + inflation) - 1 = (1.03/1.02) -1 = 0.9803% ii. after tax? • k real,AT(1 + knom1 - T))/(1 + i)] - 1 = (1 + 0.03(1 - 0.44))/(1.02)] - 1 = - 0.3137% 8. Mary earned 8% before tax on her investment. If her marginal tax rate is 44%, what is her after tax return if her income was: (pg 64) Chapter 2: Factors Affecting Retirement Planning a) Interest income o Interest income = (I%)(1 -T) = (0.08)(1 - 0.44) = 4.48% b) Capital gain o Capital gain tax = Capital gain - [(Capital gain)(50%)(marginal tax)] = 0.08 - [(0.08)(0.5)(0.44)] = 6.24% c) If inflation is 2.5%, what is her real return after tax for the interest income and capital gain? o Interest income k = [(1 + (I%)(1 -T))/(1 + inflation)] - 1 real = [(1 + (0.08)(1 - 0.44))/(1.025)] - 1 = 1.93% o Capital gain kreal(1 + nom/1 + inflation) -1 = (1.0624/1.025) - 1 = 3.648% 9. Al earned 9.2% on his RRSP investments this yr. He just read in the paper that inflation was 1.7% for the yr ended March 31, 2008. His goal was to earn a 7.5% real rate of return. a) What is Al's real rate of return o real rate of return = (1 + nom/ 1 + inflation) -1 = (1.092/1.017) -1 = 7.37% b) What should his rate of return have been? o goal: 0.075 = (1 + nom/ 1 + inflation) -1 (0.075 + 1) = (1.017) = 1 + nom nom = 9.327% Chapter 2: Factors Affecting Retirement Planning c) What would Al's real rate of return have been if inflation had been 4.2%? o real rate = (1 + nom/ 1 + inflation) -1 = (1.092/1.042) -1 = 4.79% d) If inflation is 4.7%, what rate of return did Al need to achieve to have a 7.5% real rate of return? o 0.075 = (1 + nom/ 1 + 0.047) -1 nom = 12.55% 10. Bonnie has $10,000 in an RRSP earning 8% interes
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