QUESTION 2: Ms.MoneySmart has a diversified portfolio of securities with a marke

Question

QUESTION 2:

Ms.MoneySmart has a diversified portfolio of securities with a market value of $200,000 and an adjusted cost base of $240,000. Her portfolio is a growth portfolio, which is expected to grow at 6% per year. Every purchase or sale costs 0.3% of the market value. Her marginal tax rate is 46% now and in the future. She could sell the portfolio now, take care of the taxes and reinvest again right away for 20 years in the same portfolio earning 6% per year, or she could hold the current portfolio without selling until she retires in 20 years. In either case s he will sell everything at the end of 20 years. Assume that s he had substantial taxable capital gains during the last several years.

a. Determine the after tax value of her portfolio if she sells everything now and reinvest for 20years.

b. What would be the after tax portfolio value if she chooses to hold everything for 20 years.

Explanation / Answer

a. If the portfolio is sold now, the net proceeds (after considering the sale costs) will be : 200000 (1-0.3%) = 199400. When she reinvests the cost of purchase will again be 0.3%, hence the net amount reinvested will be : 199400 * (1-0.3%) = 198801.8 - this amount will also be her cost base for arriving at taxes after 20 years. The gross value of the portfolio after 20 years : 198801.8 * (1+6%)20 = 637584.3

Taxable return : (637584.3 - 198801.8) = 438782.5 ; Taxes = 46%

Taxes = 438782.5 * 46% = 201839.95

Aftertax value = 637584.3 - 201839.95 =435744.4

Part b. Value of portfolio after 20 years : 200000 * (1+6%)20 = 641427.1

Taxable return : 641427.1 - 240000 = 401427.1 ; Taxes = 184656.5

After tax return : 641427.1 - 184656.5 = 456770.6

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