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Suppose you want to invest $10,000. You have two options: (1) Invest in California municipal bonds with an expected rate of return of 7.00%, or (2) invest in J and K Corp.’s bonds with an expected rate of return of 10.50%. Assume that your decision is based on a tax perspective. If everything else is the same for both bonds, at what tax rate would you be indifferent between these two bonds?

Respuesta :

Answer: 33.33%

Explanation:

Based on the information given in the question, the tax rate that the individual will be indifferent between these two bonds will be calculated thus:

= Corporate bond yield × (1-tax rate) = Municipal bond yield

10.50% × (1 - Tax rate) = 7.00%

(1 - Tax rate) = 7.00% / 10.50%

(1 - Tax rate) = 0.6667

Tax rate = 1 - 0.6667

Tax rate = 0.3333

Tax rate = 33.33%

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