Question

A tax-exempt security's rate is determined by mathematically setting its after-tax rate equal with that of a taxable security (TS). The tax paid on a taxable security is the marginal tax rate (MTR).

Elki would like to invest $54,000 in tax-exempt securities. He now has the money invested in a certificate of deposit that pays 5.30% annually. What rate of interest would the tax-exempt security have to pay to result in a greater return on Elki's investment than the certificate of deposit?

Work the problem assuming the following marginal tax rates:

Round the tax rates to two decimal places.

Elki's Marginal Tax Rate Tax-Exempt Equivalent Rates (in %) 12% % 22% % 24% % 32%

Answer 1

Tax exempt equivalent rate = Taxable rate*(1- marginal tax rate)

When rate =12%, equivalent rate = 5.30%(1-12%) = 4.664%

When rate = 22% equivalent rate = 5.30%(1-22%) = 4.134%

When rate = 24%, rate = 4.028%

When rate =32%, rate = 3.604%