Question

Hugh has the choice between investing in a City of Heflin bond at 3.15 percent or investing in a Surething Inc. bond at 4.85 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 Fergie has the choice between investing in a State of New York bond at 6.2 percent and a Surething Inc. bond at 9.8 percent. Assuming that both bonds have the same nontax characteristics and that Fergie has a 30 percent marginal tax rate, what interest rate does the state of New York bond need to offer to make Fergie indifferent between investing in the two bonds? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Interest rate Song earns $210.000 taxable income as an interior designer and is taxed at an average rate of 25 percent (ie. $52.500 of tax). a. If Congress increases the income tax rate such that Song's average tax rate increases from 25 percent to 30 percent, how much more income tax will she pay assuming that the income effect is descriptive? (Round your intermediate calculations and final answer to 2 decimal places.) Additional income tax b. If the income effect is descriptive, the tax base and the tax collected will increase. True False

Answer 1

Answer:

1. The following are the details given.

a) Hugh has the choice between investing

a.1) in a City of Heflin bond @ 3.15%, or

a.2) Surething Inc. bond @ 4.85%

b) Both bonds have the same non tax characteristics

c) Hugh has a 40% marginal tax rate.

Hence, interest rate does Surething Inc., need to offer to make Hugh indifferent between investing in the two bonds is as follows:

After-tax Return = Pretax Return X (1 − Marginal Tax Rate)

Therefore, Pretax return = After-tax Return/(1 − Marginal Tax Rate)=3.15%/(1-40%)=5.25%.

Hence, interest rate does Surething Inc., need to offer to make Hugh indifferent between investing in the two bonds is 5.25%.

2. The following are the details given.

a) Fergie has the choice between investing

a.1) in a State of New York Bond @ 6.2%, or

a.2) Surething Inc. bond @ 9.8%

b) Both bonds have the same non tax characteristics

c) Fergie has a 30% marginal tax rate.

Hence, interest rate does the state of New York bond need to offer, to make Fergie indifferent, between investing in the two bonds is = 9.8%-(9.8% X 30%)=6.86%.

Hence, interest rate does the state of New York bond need to offer, to make Fergie indifferent, between investing in the two bonds is 6.86%.

3. a) The details given are as follows:

a.1) Song earns $210,000 taxable income.

a.2) Average rate of tax is 25%.

a.3) Hence, tax works out to $52,500.

a.4) Congress increases average tax rate from 25% to 30%.

a.5) Income effect is descriptive.

a.6) Hence, when tax rate was 25%. the income of Song after tax works out to $157,500.

a.7) Now since tax has increased to 30%. The pretax income should be as follows:

After-tax Return/(1 − Marginal Tax Rate)=$157,500/(1-30%)=$225,000.

a.8) Now Song will pay $225,000 X 30% = $67,500 as tax

a.9) Since income effect is descriptive, Song will pay $15,000 ($67,500-$52,500) more income tax.

Hence, from the above it can be concluded that Song will pay $15,000 more income tax.

b) If the income effect is descriptive, the tax base and tax collected will increase - True.

From the above it can be concluded that if the income effect is descriptive, the tax base and tax collected will increase.