Question

Carter Corporation has some money to invest, and its treasurer is choosing between $1,000 face value City of Chicago municipal bonds and $1,000 face value U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. The Treasury bonds earn an annual income of $60 on each $1,000 bond. Carter’s marginal income tax rate is 15%. What annual after-tax income earned on each $1,000 Chicago municipal bond would make Carter’s treasurer indifferent between the two?

a 30.00

b 38.00

c 46.00

d 51.00

e 60.00

Answer 1

Compute the annual after-tax income on municipal bonds, using the equation as shown below:

Annual after-tax income = Annual income on T-bonds*(1 – Tax rate)

                                        = $60*(1 – 0.15)

                                        = $51

Hence, the annual after-tax income on municipal bonds is $51.