Dennis is currently considering investing in municipal bonds that earn 7.50 percent interest, or in taxable bonds issued by the Coca-Cola Company that pay 10.00 percent.

a. If Dennis's tax rate is 22 percent, which bond should he choose? Municipal bonds Taxable bonds

b. Which bond should he choose if his tax rate is 32 percent? Municipal bonds Taxable bonds

c. At what tax rate would he be indifferent between the bonds?

Question

Business

Leslie Cowan

9 May, 07:59

Dennis is currently considering investing in municipal bonds that earn 7.50 percent interest, or in taxable bonds issued by the Coca-Cola Company that pay 10.00 percent.

a. If Dennis's tax rate is 22 percent, which bond should he choose? Municipal bonds Taxable bonds

b. Which bond should he choose if his tax rate is 32 percent? Municipal bonds Taxable bonds

c. At what tax rate would he be indifferent between the bonds?

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Answers (1)

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Emilio Kaufman · Answer 1

a. Post-tax interest rate on taxable bonds issued by the Coca-Cola Company = 100%-22% = 10*78% = 7.80

Dennis will choose Taxable bonds because it gives higher post-tax interest rate of 7.80% as against 7.50% on municipal bonds.

b. Post-tax interest rate on taxable bonds issued by the Coca-Cola Company

=100%-32% = 10*68% = 6.80%

Dennis will choose municipal bonds because it gives higher tax free interest rate of 7.50% as against 6.80% on Taxable bonds.

c. Dennis will indifference when post-tax interest on Taxable bonds is equal to tax free interest on municipal bonds i. e 7.50%.

Let x% represent the expected tax rate.

=x% * 10%=7.50%

=10x%=7.50%

Divide both side by 10

=x%=7.5/10=0.75

=1-0.75=25%

At 25% tax rate, Dennis would be indifferent between the bonds.