Question

Jackson has the choice to invest in City of Mitchell bonds or Sundial Inc. corporate bonds that pays 6.4 percent interest. Jackson is a single taxpayer who earns $57,500 annually. Assume that the city of Mitchell bonds and the Sundial, Inc. bonds have similar risk. What interest rate would the city of Mitchell have to pay in order to make Jackson indifferent between investing in the city of Mitchell and the Sundial, Inc. bonds for 2019? (Use tax rate schedule)

Answer 1

Since Jackson is earning $ 57500 annually, therefore the applicable tax rate is 22% as the Jackson's income falls in 22% bracket ($ 39476 to $ 84200).

Hence, bonds will be taxed at 22% and we have to find out the rate at which they yield a 6.4% after tax. It is calculated as follows:

Pre tax x (1 - Tax rate) = After tax

Pre tax x (1 - 22%) = 6.4%

Pre tax x (1 - 0.22) = 0.064

Pre tax = 0.064 / 0.78

= 0.082

= 8.2%

Therefore, at 8.2% interest rate the city of Mitchell would have to pay in order to make Jackson indifferent between investing in the city of Mitchell and the Sundial, Inc. bonds for 2019.