Question

Hugh has the choice between investing in a City of Heflin bond at 5.70 percent or investing in a Surething Inc. bond at 9.25 percent. Assuming that both bonds have the same nontax characteristics and that Hugh has a 40 percent marginal tax rate, what interest rate does Surething Inc. need to offer to make Hugh indifferent between investing in the two bonds? (Round your answer to 2 decimal places.) Interest rate Interest rate %

Answer 1

Ans 1 After tax return= pre tax return*(1-marginal tax rate)

Pre tax return = 9.25/(1- marginal tax rate)

So, 9.25/0.6 =15.42% interest should be offered by surething inc.

Ans 2

a.

Taxes payable by song on income of $114,000 is $22,800 i.e. 20% of $114,000

But due to increase in tax rate and decrease in income would be government will get tax amount of $21,375 i.e. 25% of 85,500

So, there will be an overall decrease in government earning of taxes by $1425 (Calculated as 22800-21375)

b. this kind of shifting of taxpayer is endowment effect.

c. Disposable income means the income left over after deduction of taxes, which is available to be spent or saved as per wish.

Taxpayers with more disposable income will act like above.