Question

Problem 1-45 (LO 1-3, LO 1-4) (Algo) Fergie has the choice between investing in a State of New York bond at 9.0 percent and a Surething Inc. bond at 10.1 percent. Assuming that both bonds have the same nontax characteristics and that Fergie has a 30 percent marginal tax rate, in which bond should she invest? Fergie should invest in the

Answer 1

Required:

Rate ofreturn on Surething bond = 10.1%

Rate of return on State of New York bond = 9%

Marginal tax = 30%

After tax rate of return on Surething bond

= 10.1% - (10.1% * 30%)

= 10.1% - 3.03%

= 7.07%

Investment in State of New York is tax exempt. Hence after tax return on new york bond = 9%

After tax rate of return on Surething bond (7.07%) is less than New York bond (9%), So Fergie should invest in New York bonds.