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Estate Planning - pg 152 (Solutions section)

Hi there,
trouble with below answer:

'It is not appropriate to use the expected return of the assets used to fund spending needs to calculate the capitalized value of their core capital needs, because the risk of the Pearsalls’ spending needs is unrelated to the risk of the investment portfolio used to fund those needs. (understood) Although the annual spending cash flows are not riskless, a risk-free rate should be used to calculate the present value of the cash flows as their uncertainty is unrelated to market risk factors that would be priced in a normal asset pricing model, making their beta equal to zero. (didnt understand this sentence)'

Thanks very much.

Best Answer

Answers

  • Hi there,
    trouble with below answer:

    'It is not appropriate to use the expected return of the assets used to fund spending needs to calculate the capitalized value of their core capital needs, because the risk of the Pearsalls’ spending needs is unrelated to the risk of the investment portfolio used to fund those needs. (understood) Although the annual spending cash flows are not riskless, a risk-free rate should be used to calculate the present value of the cash flows as their uncertainty is unrelated to market risk factors that would be priced in a normal asset pricing model, making their beta equal to zero. (didnt understand this sentence)'

    Thanks very much.
  • Thanks very much for your clarification - much appreciated.
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