Question

Suppose that the tax rate is 25% and compute the before-tax real interest rate and the...

Suppose that the tax rate is 25% and compute the before-tax real interest rate and the after-tax real interest rate in the following situations.

a. Nominal interest rate = 9%, inflation is 4%.

b. Nominal interest rate = 8%, inflation is 3%.

c. Nominal interest rate = 7%, inflation is 4%.

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Homework Answers

Answer #1

Solution:-Given date

before tax nominal rateI-r

inflation rate-i

tax rate-t

Before tax real interest rate = r – i

After tax rea interest rate = r(1-t) – i

a. Nominal interest rate = 9%, inflation is 4%.

Before tax real interest rate = 9% - 4%=5%

after tax real interest rate = 9%(1-0.25%) – 4%= 2.75%

b. Nominal interest rate = 8%, inflation is 3%.

Before tax real interest rate = 8% - 3%=5%

after tax real interest rate = 8%(1-0.25%) – 3%= 3%

c. Nominal interest rate = 7%, inflation is 4%.

Before tax real interest rate = 7% - 4%=3%

after tax real interest rate = 7%(1-0.25%) – 4%= 1.25%

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