Question

Problem 4-47 (LO. 4, 5) Roy decides to buy a personal residence and goes to the bank for a $150,000 loan. The bank tells him that he can borrow the funds at 4% if his father will guarantee the debt. Roy's father, Hal, owns a $150,000 CD currently yielding 3.5%. The Federal rate is 3%. Hal agrees to either of the following: Roy borrows from the bank with Hal's guarantee to the bank. Hal cashes in the CD (with no penalty) and lends Roy the funds at 2% interest. Hal is in the 32% marginal tax bracket. Roy, whose only source of income is his salary, is in the 12% marginal tax bracket. The interest Roy pays on the mortgage will be deductible by him. Considering only the tax consequences, answer the following. a. The loan guarantee: Hal's interest income from the CDs would be $fill in the blank 1 before taxes and $fill in the blank 2 after taxes. Roy's interest expense from the bank loan would be $fill in the blank 3 before taxes and $fill in the blank 4 after taxes. This arrangement would produce an overall cash flow after taxes to the family of $fill in the blank 6 . b. The loan from Hal to Roy: Hal's tax on the imputed interest income from the loan to Roy would be $fill in the blank 7 . Roy's tax benefit from the imputed interest expense from Hal's loan would be $fill in the blank 8 . This arrangement would produce an overall cash flow after taxes to the family of $fill in the blank 10 . c. Which option will maximize the family's after-tax wealth?

Answer 1

Hals interest income (before tax)	(150000*3.5/100)	5250
after tax	(5250*.68)	3570
roys interst expense ( before tax)	(150000*4/100)	6000
after tax	(6000*.12)	720
net tax exoense	(5250-3570)	1680
part B
loan from hal to roy
hals interst revenue	150000*2/100	3000
after tax	3000*.68	2040
decrese inn before interst		2250
after interst		1530
roys interst expense (before tax)		3000
tax	3000*12/100	360
net tax expense		2640
so net decrese		600
decrese in option B is len so they should so far option B loan from hal to roy