Question

1. Ms. Drake is deciding between investing $50,000 in two different municipal bonds, both of which have the same risk. The first option is state of Colorado bonds paying interest of 3.35%. The second option is state of Texas bonds paying interest of 3.50%. All income from either bond investment is nontaxable at the federal level.

   Because Ms. Drake is a resident of Colorado, any income from the Colorado bond is nontaxable at the state level as well. However, any income from the Texas bond would be taxable in Colorado at Ms. Drake’s state tax rate of 4.63%. Additionally, any state income taxes paid to Colorado on the Texas bond income would be deductible on Ms. Drake’s federal tax return, benefiting her at her federal tax rate of 35%.

   Considering all of the above facts, which bond investment offers Ms. Drake the greater post-tax return – and by how much? Support your answer with clearly labeled calculations.

Answer 1

Amount in $

Investment in	Colorado Bond	Texas Bond
Interest on $ 50,000 at 3.35%	1,675	-
Interest on $50,000 at 3.5 %	-	1750
Tax at Colorado at 4.63%	-	(81)

Income earned after local taxes

1,675

1,669

Federal tax at 35% rate	586	584
Tax credt available	0	(81)

Income after federal tax

1,089

1,166

Ms. Drake can invest her $ 50,000 in her Texas bond for below reasons:

a. Interest rate for texas bond is 0.15% more when compared to Colorado bond

b. Even there is a tax of 4.63%i s extra at state level for Texas bond , Income earned after taxes more as per the above table.

So Ms Drake can invest her $50,000 in Texas Bond to earn more returns