Question

You are considering investing in a Lake County municipal bond that had a promised return of 6.5% and Southern Products Corporation bond with a promised return of 7.8% . In an after tax basis, which is a better investment for you if you are in the 22% tax bracket?

Answer 1

Municipal Bond rate of return = 6.5%

Generally, Municipal Bonds are tax free. Thus, after-tax rate of return of municipal bond is same as its promised rate of return.

after-tax rate of return of Municipal bond = 6.50%

Corporation Bond promised rate of return = 7.80%

Tax rate = 22%

Thus,

after-tax rate of return of Corporation bond = 7.80%*(1-22%) = 6.08%

Municipal return is higher than after-tax return of corporation bond. Thus,

Investment in Municipal Bond is a better option.