Question

Dennis is currently considering investing in municipal bonds that earn 8.55 percent interest, or in taxable bonds issued by the Coca-Cola Company that pay 11.4 percent.

a. If Dennis’s tax rate is 20 percent, which bond should he choose?

Taxable bonds or Municipal bonds

b. Which bond should he choose if his tax rate is 30 percent?

Taxable bonds or Municipal bonds

c. At what tax rate would he be indifferent between the bonds?

Tax Rate ___ %

What strategy is this decision based upon?

	Development planning strategy
	Business planning strategy
	Decision planning strategy
	Marketing planning strategy
	Conversion planning strategy
	Timing strategy
	Income shifting strategy

Answer 1

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Dennis
Dennis should choose that bond from which after tax income is highest. Municipal bonds are tax free but coca cola bonds are taxable.
a. If Dennis’s tax rate is 20 percent, which bond should he choose?
Return from Coca Cola bonds	11.40%
Less: Tax rate at 20%	2.28%
After Tax rate	9.12%
After Tax rate from Coca Cola bond is 9.12%. But from Municipal bond is 8.55%.
After Tax rate from Coca Cola bond is greater than Municipal bond so Dennis should choose Coca Cola bond.
b. Which bond should he choose if his tax rate is 30 percent?
Return from Coca Cola bonds	11.40%
Less: Tax rate at 30%	3.4200%
After Tax rate	7.98%
After Tax rate from Coca Cola bond is 7.98%. But from Municipal bond is 8.55%.
After Tax rate from Coca Cola bond is less than Municipal bond so Dennis should choose Municipal bond .
c. At what tax rate would he be indifferent between the bonds?
So After Tax rate from Coca Cola bond is 11.40%- X% of 11.40%.
Therefore,
11.40%- X% of 11.40%=	8.55%
11.40%- 8.55%	X% of 11.40%
2.85%=	X% of 11.40%
X%=	2.85%/ 11.40%
X%=	25.00%
So at tax rate of 25% Dennis would be indifferent between the bonds.
What strategy is this decision based upon?
Income shifting strategy