You have recently been appointed as a pension fund
specialist for your company and you have been tasked to perform
valuation on some of the pension fund portfolios.
Your company wants to know the minimum annual return required on
the pension fund in order to make all required payments over the
next five years and not diminish the current asset base. The fund
currently has assets of R500 million.
Required:
3.1 Determine the rate of return if outflows are expected to exceed
inflows by R50 million per year.
3.2 Determine the rate of return with the following fund cash
flows.
yr 1 inflows R55 000 000 outflows R100 000 000
yr2 inflows R60 000 000 outflows R110 000 000
yr3 inflows R60 000 000 outflows R120 000 000
yr4 inflows R60 000 000 outflows R135 000 000
yr5 inflows R64 000 000 outflows R145 000 000
3.3 Consider the cash flows in part 3.2. What will happen to your
asset base if you earn 10%?20%?
Part 3.1
Given Initial Fund = R500mn, Every year net outflows for 5 years = Outflows - Inflows = 50mn
Each year if we make 50mn on the initial fund, it should be sufficient to pay off the net ouflows of 50mn.
So required minimum rate of return to see that there is no diminish in asset base = 50mn/500mn = 10%
Part 3.2
Determining Rate of return is not possible without the use of a calculator or an Excel sheet.
Given below I used an excel sheet and used the goal seek tool in DATA tab of excel to arrive at the Required Rate of Return
F | G | H | I | J | K |
23 | Rate of return | 12.00% | |||
24 | Year | Inflows | Outflows | Net cashflow | Balance |
25 | 0 | 500000000 | 500000000 | 500000000 | |
26 | 1 | 55000000 | 100000000 | -45000000 | 515022525.2 |
27 | 2 | 60000000 | 110000000 | -50000000 | 526848430.3 |
28 | 3 | 60000000 | 120000000 | -60000000 | 530093976.7 |
29 | 4 | 60000000 | 135000000 | -75000000 | 518729134.8 |
30 | 5 | 64000000 | 145000000 | -81000000 | 500000000.0 |
Given below is the formula sheet used
F | G | H | I | J | K |
23 | 0.120045050461063 | ||||
24 | Year | Inflows | Outflows | Net cashflow | Balance |
25 | 0 | 500000000 | =H25-I25 | =J25 | |
26 | 1 | 55000000 | 100000000 | =H26-I26 | =K25*(1+K$23)+J26 |
27 | 2 | 60000000 | 110000000 | =H27-I27 | =K26*(1+K$23)+J27 |
28 | 3 | 60000000 | 120000000 | =H28-I28 | =K27*(1+K$23)+J28 |
29 | 4 | 60000000 | 135000000 | =H29-I29 | =K28*(1+K$23)+J29 |
30 | 5 | 64000000 | 145000000 | =H30-I30 | =K29*(1+K$23)+J30 |
After I give the following data and formulae in excel. Go to DATA Tool Bar --> What-If Analysis --> Goal Seek.
We get the required rate of Return in K23 cell. 12%
Part 3.3
If we have a return rate = 10%, the asset base reduces to $436,720,500 as the required rate is 12% to maintain the asset base without diminishing. Given below is the working
F | G | H | I | J | K |
23 | 10.00% | ||||
24 | Year | Inflows | Outflows | Net cashflow | Balance |
25 | 0 | 500000000 | 500000000 | 500000000 | |
26 | 1 | 55000000 | 100000000 | -45000000 | 505000000 |
27 | 2 | 60000000 | 110000000 | -50000000 | 505500000 |
28 | 3 | 60000000 | 120000000 | -60000000 | 496050000 |
29 | 4 | 60000000 | 135000000 | -75000000 | 470655000 |
30 | 5 | 64000000 | 145000000 | -81000000 | 436720500.0 |
If the return rate = 20%, the asset base appreciates to $807,048,000 as the required rate is 12% to maintain the asset base without diminishing or appreciating. Given below is the working.
F | G | H | I | J | K |
23 | 20.00% | ||||
24 | Year | Inflows | Outflows | Net cashflow | Balance |
25 | 0 | 500000000 | 500000000 | 500000000 | |
26 | 1 | 55000000 | 100000000 | -45000000 | 555000000 |
27 | 2 | 60000000 | 110000000 | -50000000 | 616000000 |
28 | 3 | 60000000 | 120000000 | -60000000 | 679200000 |
29 | 4 | 60000000 | 135000000 | -75000000 | 740040000 |
30 | 5 | 64000000 | 145000000 | -81000000 | 807048000.0 |
Both the above workings have the same formulae in the cells as of the first given formulae sheet.
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