Question

Personal After-Tax Yield Corporate bonds issued by Johnson Corporation currently yield 12%. Municipal bonds of equal risk currently yield 6%. At what tax rate would an investor be indifferent between these two bonds? Round your answer to two decimal places. %

Answer 1

1). Since bonds have equal risk, therefore

After tax yield = Before tax yield (1 - T)

(12%)(1 - T) = (6%)(1 - 0)

1 - T = 6% / 12%

1 - T = 0.5

T = 1 - 0.5 = 0.5, or 50%

2). AT&T Bond

After tax rate of return = 9.25% * (1 - T) = 9.25% * (1 - 0.40) = 9.25% * 0.60 = 5.55%

State Florida Muni Bonds

After tax rate of return = 6% * (1 - T) = 6% * (1 - 0) = 6% * 1 = 6.00%

AT&T preferred stock

After tax rate of return = 7.75% - [7.75% * (1 - Exemption Limit) * T]

= 7.75% - [7.75% * (1 - 0.70) * 0.40]

= 7.75% - 0.93%

= 6.82%