QUESTIONS 7, 8, AND 9, INCLUDING GUIDELINE ANSWERS (STUDY SESSION 9) A...

4.427 percent, which when adjusted for the 40 percent tax rate, results in a 7.38 percent pretax return (4.427%/(1 − 0.04) = 7.38%). Annual Cash Flow = –£26,000 Christopher’s Annual Salary 80,000Less: Taxes (40%) –32,000Living Expenses –74,000Net Annual Cash Flow –£26,0002004 Level III Guideline Answers Morning Session - Page 5 Asset Base = £1,235,000 Inheritance 900,000Barnett Co. Common Stock 220,000Stocks and Bonds 160,000Cash 5,000Subtotal £1,285,000Less One-time Needs: Down Payment on House –30,000Charitable Donation –20,000Total Assets £1,235,000Note: No inflation adjustment is required in the return calculation because increases in living expenses will be offset by increases in Christopher’s salary. B. The Maclins’ investment policy statement should include the following constraints: i. Time horizonThe Maclins have a two-stage time horizon, because of their changing cash flow and resource needs. The first stage is the next 18 years. The second stage begins with their retirement and the university education years for their children. ii. Liquidity requirements The Maclins have one-time immediate expenses (£50,000) that include the deposit on the house they are purchasing and the charitable donation in honor of Louise’s father. iii. Tax concernsThe U.K. has a 40 percent marginal tax rate on both ordinary income and capital gains. Therefore there is no preference for investment returns from taxable dividends or interest over capital gains. Taxes will be a drag on investment performance because all expenditures will be after tax. iv. Unique circumstancesThe large holding of the Barnett Co. common stock (representing 18 percent of the Maclins’ total portfolio) and the resulting lack of diversification is a key factor to be included in evaluating the risk of the Maclins’ portfolio and in the future management of the Maclins’ assets. The Maclins’ desire not to invest in alcohol and tobacco stocks is another constraining factor, especially in the selection of any future investment style or manager. Morning Session - Page 6 LEVEL III, QUESTION 3 Topic: Portfolio Management − Individual Minutes: 18 Reading References: