Question

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.

ge 15 of 17 © UNISA Graduate School of Business Leadership
End of Year
Inflows
Outflows
1
R55,000,000
R100,000,000
2
60,000,000
110,000,000
3
60,000,000
120,000,000
4
60,000,000
135,000,000
5
64,000,000
145,000,000
3.3. Consider the cash flows in part (3.2). What will happen to your asset base if you earn 10 %? 20 %?

Answer 1

1]

Annual cash outflow = R50 million

Current value of assets = R500 million

Minimum annual return required = annual cash outflow / current value of assets = R50 million / R500 million = 0.10, or 10%

2]

The minimum annual return required is calculated using IRR function in Excel. The current value of assets is R500 million. This is treated as a cash outflow in year 0, and a cash inflow in year 5. That way, the original value of assets (R500 million) is recovered at the end of year 5

IRR is calculated to be 12.00%

3]

If you earn 10%, the calculation of asset base is below :

interest earned = rate of return * beginning asset base

net cash flow = cash inflow + interest earned - cash outflow

ending asset base = beginning asset base + net cash flow

Ending asset base is $436,720,500

If you earn 20%, the calculation of asset base is below :

ending asset base is $807,048,000