Question

Walt, who is in the 35% tax bracket, sells taxable bonds (at no gain or loss) which yielded $900 of interest annually and purchases tax-exempt bonds yielding $600 of annual interest. What is the net cash effect of these transactions to Walt for the year?

a. Decreases by $300.

b. Increases by $915.

c. Decreases by $900.

d. Increases by $15.

e. None of the above.

Answer 1

First lets look at Walt's net cash when he held taxable bond:

Annual Interest = $900

Less:Tax @35% = ($315)

Net Cash earned = $585

Now lets look at Walt's net cash when he holds tax exempt bonds:

Annual Interest = $600

Less:Tax exempt = Nil

Net Cash earned = $600

Net cash earned increases from $585 to $600, that is by $15.

So the net cash effect is :-

d. Increases by $15.