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27 June, 17:15

James invests $100,000 in a city of Athens bond that pays 8% interest. Alternatively, James could have invested the $100,000 in a bond recently issued by HighTech, Inc. that pays 10% interest with similar risk as the city of Athens bond. Assume that James's marginal tax rate is 25%. Which bond should James should choose and why?

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  1. 27 June, 18:16
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    The James should choose city Athens bond because the amount of interest earned in city Athens bond is more.

    Explanation:

    Given:

    Amount invested by James = $100,000

    Rate of interest offered by city Athens bond = 8%

    also,

    rate of interest paid by the HighTech Inc. = 10%

    Marginal tax rate = 25%

    Now,

    The amount of interest earned from the city Athens bonds

    = Amount invested * Interest rate

    = $100,000 * 0.08

    = $8,000

    and,

    The amount of interest earned from the HighTech Inc bonds

    = Amount invested * Tax rate

    = The amount of interest earned from the city Athens bonds

    = $100,000 * 0.10

    = $10,000

    Now,

    the actual amount received after the marginal tax

    = Interest earned - Marginal tax

    = $10,000 - 0.25 * $10,000

    = $7,500

    Since,

    the amount of interest earned in city Athens bond is more

    Hence,

    The James should choose city Athens bond
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