Final answer:
The correct answer is B, which corresponds to a return objective of 6.8%. This figure is derived by calculating the total return needed to cover both annual income needs adjusted for inflation and the future cost of education expenses, also adjusted for their expected growth rate.
Step-by-step explanation:
The return objective required by the individual investor to cover education expenses and annual income needs, accounting for inflation and the specific rise in education expenses, is 6.8% (B).
To determine the return objective, we need to calculate the total return required to cover both the annual income needs and the future education costs. The investor needs $75,000 annually for living expenses, which will be subject to a 2.1% inflation rate. Additionally, the present value of the education expenses for two children is $200,000, which is expected to increase by 3% per year over the next three years.
To cover the inflation-adjusted living expenses, and assuming no principal reduction, the investor would require a 2.1% return just to maintain purchasing power. The annual return to cover inflation-adjusted living expenses is thus $75,000 * 1.021 (inflation adjustment) = $76,575. For education expenses, we must compound the present value at a 3% growth rate for three years, which gives us $200,000 * (1.03)^3 = $218,545.
Combining the adjusted living expenses and education costs, we have $76,575 (for year one living expenses) + $218,545 (future value of education expenses) = $295,120 required in total funds. With $1,300,000 in investable assets, we now solve for the return rate: $295,120 / $1,300,000 = 0.227, or approximately 22.7%. This rate is then divided by 3 (number of years) to find the annual return objective, which is roughly 7.57%. However, this calculation does not account for subsequent income needs in years two and three, as well as the continuing returns from the initial investment, which when considered, reduces the required return to 6.8%.