Question

Melinda invests $300,000 in a City of Heflin bond that pays 6.4 percent interest. Alternatively, Melinda could have invested the $300,000 in a bond recently issued by Surething, Inc. that pays 8 percent interest with similar risk and other nontax characteristics to the City of Heflin bond. Assume Melinda’s marginal tax rate is 20 percent.

What is her after-tax rate of return for the City of Heflin bond?

How much implicit tax does she pay on the City of Heflin bond?

How much explicit tax would she have paid on the Surething, Inc. bond?

What is her after-tax rate of return on the Surething, Inc. bond

Answer 1

Melinda invests $300,000 in a City of Heflin bond that pays 6.4% interest. Alternatively, Melinda could have invested the $300,000 in a bond recently issued by Surething, Inc., that pays 8% interest with similar risk and other non tax characteristics to the City of Heflin bond. Assume Melinda's marginal tax rate is 20%.

A. What is her after-tax rate of return for the City of Heflin bond?

6%

B. How much implicit tax does she pay on the City of Heflin bond?

300000*6.4%*20/80

$4,800

C. How much explicit tax would she have paid on the Surething, Inc.,bond?

20%----------$4800

D. What is her after-tax rate of return on the Surething, Inc., bond?

300000*8%*80%

$19,200