Question

Fergie has the choice between investing in a State of New York bond at 3.6 percent and a Surething Inc. bond at 6 percent. Assuming that both bonds have the same nontax characteristics and that Fergie has a 30 percent marginal tax rate, what interest rate does the state of New York bond need to offer to make Fergie indifferent between investing in the two bonds? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Answer -

To be indifferent between investing in the two bonds, the State of New York bond should provide Fergie the same after-tax rate of return as the Surething bond.

Fergie's after tax rate of return on the Surething bond is 4.2 percent (i.e., 6% interest income - (6% × 30%) tax = 4.2%).

Therefore, the state of New York needs to offer a 4.2 percent interest rate to generate a 4.2 percent after-tax return to make Fergie indifferent between investing in the two bonds.