Question

based on the after-tax returns, at what federal tax rate is an investor better off choosing a tax-exempt 5.31 percent municipal bond over a taxable 7.62 percent corporate bond?

The after-tax return on the corporate bond when the tax rate is 10% is ___% (round to two decimal places)

Answer 1

(a) Let the tax rate be t

Return on corporate tax bond = 7.62%

After tax return on corporate tax bon = 7.62(1 - t)

Return on tax exempt bond = 5.31%

The investor will choose the tax exempt bond when, 5.31 > 7.62(1-t)

=> t > 1 - 5.31/7.61

=> t > 0.3022

=> t > 30.22%

Hence, if the tax rate is more than 30.22%, investor is better off in choosing tax exempt bond

(b) When tax rate = t = 10%,

After tax return on corporate bond = 7.62(1 - 0.10) = 6.86%