Question

A 5-year corporate bond yields 8.00%. A 5-year municipal bond of equal risk yields 6.50%. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds? (Round your final answer to two decimal places.)

a. 15.56

b. 14.63

c. 21.56

d. 18.75

e. 20.06

please show work

Answer 1

Yield on corporate bonds = 8%

Yield on municipal bonds = 6.5%

Let Tax rate = ' t'

To be indifferent between the two bonds,

6.5% = 8%/(1-t)

(1-t) = 6.5%/8% = 0.8125

t = 0.1875 = 18.75%'

Answer is d. 18.75