Question

Bill’s salary at the jet-engine manufacturing plant places his
household in the 20% tax bracket. Bill is contemplating buying one
of two bonds – a Peg City municipal bond or a Government Treasury
bond – but is having some trouble deciding which would be the
better investment. Both are discount bonds, have a face value of
$10,000, mature in one year, and are identical in terms of risk.
The current price of the Treasury bond is $9,803.92 and the
municipal bond is $9,852.22. *Hint*: The municipal bond is
tax-exempt.

1) What is the yield-to-maturity (YTM) on the Peg City bond? (provide your answer in % with one decimal point of accuracy)

2) What is the yield-to-maturity (YTM) on the Treasury bond? (provide your answer in % with one decimal point of accuracy)

3) Now consider the after tax YTMs. Which bond offers the greater after-tax return for Bill's household? (i.e., municipal or federal?). Briefly justify/explain your answer.

Answer #1

The YTM can be found using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

1. YTM of Peg City bond=RATE(nper,pmt,pv,fv,type)

nper=1 (maturity=1 year)

pmt=0

pv=9852.22

fv=10000

=RATE(1,0,-9852.22,10000,0)=1.50%

YTM of municipal bond=1.50%

As mentioned in the above question, it is totally exemped from the tax. Hence, YTM=1.50%

2. YTM of Government Treasury bond=RATE(nper,pmt,pv,fv,type)

nper=1 (maturity=1 year)

pmt=0

pv=9803.92

fv=10000

=RATE(1,0,-9803.92,10000)=2.0%

Here, YTM=2.0%

After tax YTM of Treasury bond=2.0%*(1-20%)=1.6%

3. The YTM of Treasury bond is higher than YTM of Municipal bond by 10 basis points (0.1%). Hence, Bill should purchase Treasury bond which can yield 1.6% (after tax) while Municipal bond yields only 1.5%

Your task is to determine the WACC for a given firm using what
you know about WACC as well as data you can find through research.
Your deliverable is a brief report in which you state your
determination of WACC, describe and justify how you determined the
number, and provide relevant information as to the sources of your
data.
Select a publicly traded company that has debt
or bonds and common stock to calculate the current WACC. One good
source...

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