Question

19. Mr. Green has $15,000 to invest. He is undecided about putting the money into tax-exempt municipal bonds paying 3.5 percent annual interest or corporate bonds paying 4.75 percent annual interest. The two investments have the same risk. a. Which investment should Mr. Green make if his marginal tax rate is 32 percent? b. Would your conclusion change if Mr. Green's marginal tax rate is only 12 percent?

Answer 1

When the tax rate is 32%

After tax corporate bond yield = 4.75 % * (1 - 0.32)

= 3.23%

Since the after tax corporate bond yield is lower than municipal bonds yield, Mr Green should prefer to invest in municipal bonds

If the tax rate is 12%

After tax corporate bond yield = 4.75 % * (1 - 0.12)

= 4.18%

Since the after tax corporate bond yield is higher than municipal bonds yield, Mr Green should prefer to invest in the corporate bond