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6. Susan Fairfax is president of Reston Industries, a U.S.-based company whose sales are entirely domestic and whose shares are listed on the New York
6. Susan Fairfax is president of Reston Industries, a U.S.-based company whose sales are entirely domestic and whose shares are listed on the New York Stock Exchange. The following are addi- tional facts concerning her current situation: Fairfax is single, aged 58. She has no immediate family, no debts, and does not own a resi- dence. She is in excellent health and covered by Reston-paid health insurance that continues after her expected retirement at age 65. Her base salary of $500,000/year, inflation-protected, is sufficient to support her present life- style but can no longer generate any excess for savings. She has $2,000,000 of savings from prior years held in the form of short-term instruments. Reston rewards key employees through a generous stock-bonus incentive plan but provides no pension plan and pays no dividend. Fairfax's incentive plan participation has resulted in her ownership of Reston stock worth $10 million (current market value). The stock, received tax-free but subject to tax at a 35% rate (on entire proceeds) if sold, is expected to be held at least until her retirement. Her present level of spending and the current annual inflation rate of 4% are expected to con- tinue after her retirement. Fairfax is taxed at 35% on all salary, investment income, and realized capital gains. Assume her composite tax rate will continue at this level indefinitely. Fairfax's orientation is patient, careful, and conservative in all things. She has stated that an annual after-tax real total return of 3% would be completely acceptable to her if it was achieved in a context where an investment portfolio created from her accumulated savings was not sub- ject to a decline of more than 10% in nominal terms in any given 12-month period. To obtain Current Allocation (millions) Current Allocation Percentage Current Yield Expected Annual Return Standard Deviation of Returns Asset $ 40 4.0% 5.0 60 U.S. money market bond fund Intermediate global bond fund Global equity fund Bertocchi Oil and Gas common stock Direct real estate Venture capital Total 1.0 300 400 4.0% 5.0 10.0 15.0 11.5 20.0 2.0% 9.0 15.0 25.0 700 16.5 3.0 0.0 35.0 500 $2,000 100% 3. George More is a participant in a defined contribution pension plan that offers a fixed-income fund and a common stock fund as investment choices. He is 40 years old and has an accumulation of $100,000 in each of the funds. He currently contributes $1,500 per year to each. He plans to retire at age 65, and his life expectancy is age 80. a. Assuming a 3% per year real earnings rate for the fixed-income fund and 6% per year for com- mon stocks, what will be George's expected accumulation in each account at age 65? b. What will be the expected real retirement annuity from each account, assuming these same real earnings rates? C. If George wanted a retirement annuity of $30,000 per year from the fixed-income fund, by how much would he have to increase his annual contributions? 6. Susan Fairfax is president of Reston Industries, a U.S.-based company whose sales are entirely domestic and whose shares are listed on the New York Stock Exchange. The following are addi- tional facts concerning her current situation: Fairfax is single, aged 58. She has no immediate family, no debts, and does not own a resi- dence. She is in excellent health and covered by Reston-paid health insurance that continues after her expected retirement at age 65. Her base salary of $500,000/year, inflation-protected, is sufficient to support her present life- style but can no longer generate any excess for savings. She has $2,000,000 of savings from prior years held in the form of short-term instruments. Reston rewards key employees through a generous stock-bonus incentive plan but provides no pension plan and pays no dividend. Fairfax's incentive plan participation has resulted in her ownership of Reston stock worth $10 million (current market value). The stock, received tax-free but subject to tax at a 35% rate (on entire proceeds) if sold, is expected to be held at least until her retirement. Her present level of spending and the current annual inflation rate of 4% are expected to con- tinue after her retirement. Fairfax is taxed at 35% on all salary, investment income, and realized capital gains. Assume her composite tax rate will continue at this level indefinitely. Fairfax's orientation is patient, careful, and conservative in all things. She has stated that an annual after-tax real total return of 3% would be completely acceptable to her if it was achieved in a context where an investment portfolio created from her accumulated savings was not sub- ject to a decline of more than 10% in nominal terms in any given 12-month period. To obtain Current Allocation (millions) Current Allocation Percentage Current Yield Expected Annual Return Standard Deviation of Returns Asset $ 40 4.0% 5.0 60 U.S. money market bond fund Intermediate global bond fund Global equity fund Bertocchi Oil and Gas common stock Direct real estate Venture capital Total 1.0 300 400 4.0% 5.0 10.0 15.0 11.5 20.0 2.0% 9.0 15.0 25.0 700 16.5 3.0 0.0 35.0 500 $2,000 100% 3. George More is a participant in a defined contribution pension plan that offers a fixed-income fund and a common stock fund as investment choices. He is 40 years old and has an accumulation of $100,000 in each of the funds. He currently contributes $1,500 per year to each. He plans to retire at age 65, and his life expectancy is age 80. a. Assuming a 3% per year real earnings rate for the fixed-income fund and 6% per year for com- mon stocks, what will be George's expected accumulation in each account at age 65? b. What will be the expected real retirement annuity from each account, assuming these same real earnings rates? C. If George wanted a retirement annuity of $30,000 per year from the fixed-income fund, by how much would he have to increase his annual contributions
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