Question

Problem 4-47 (LO. 4,5) Roy decides to buy a personal residence and goes to the bank for a $150,000 loan. The bank tells him that he can borrow the funds at 4% If his father will guarantee the debt. Roy's father, Hal, owns a $150,000 CD currently yielding 3.5%. The Federal rate is 3%. Hal agrees to either of the following: • Roy borrows from the bank with Hal's guarantee to the bank. • Hal cashes in the CD (with no penalty) and lends Roy the funds at 2% Interest. Hal is in the 32% marginal tax bracket. Roy, whose only source of income is his salary, is in the 12% marginal tax bracket. The Interest Roy pays on the mortgage will be deductible by him. Considering only the tax consequences, answer the following. a. The loan guarantee: Hal's interest income from the CDs would be before taxes and s after taxes. after taxes Roy's interest expense from the bank loan would be $ before taxes and This arrangement would produce an overall cash flow after taxes to the family of s b. The loan from Hal to Roy: Hal's tax on the imputed interest income from the loan to Roy would be $ Roy's tax benefit from the imputed interest expense from Hal's loan would be s This arrangement would produce an overall cash flow after taxes to the family of $ c. Which option will maximize the family's after tax wealth?

Answer 1

Oprion A LOAN GAURAN TEE - Hal's interest dricomer 150000X3.Sov. $52506 Before fac so Aftor Tao s 5250x 0,68 I. =$3570 Roy's Internot eep in 150060x42 E G60oo Beforepo. After gaps 8000 X 9.12 -462 720 foner Tax expe&5250 So NES RERUCDON 2-8250-357 R$ 1680

Option B: LOAN FROM HAL TO Roy? Hal's Interest Renemesa i5oooox_2. 3ooo so Afrorlar 3000x0,68 =4204o [Decrease in Beforefan ant. a 2250] After tax ont = 1530 Roy's interest Expen 3000 Before Tax Taxi 3000 x 22% Š8360 so Ner Tao exp. 426 YO So Nerdecrease =8600 Song Decrease in Option Bis heb Has they should go for.Option B, Loong from HALTO Ror.