Question

Alpha Corporation is considering investing in several municipal bonds and AAA corporate bonds Ch VI R7: that pay rates of return of eight percent and six percent, respectively. Additionally, it is also contemplating preferred stock on a publicly traded company with a dividend vield of five percent. Alpha Corporation would only acquire a maximum of 10 percent of total market capitalization of the publicly traded company. If Aipha Corporation were in the 35 percent tax bracket, what is the best investment option?

Answer 1

Alpha Corporation should invest in municipal bonds that pay tax free rate of return of 8%, which is the highest amongst all the available options. Municipal bonds are tax exempt for investors and hence, investors do not have pay any tax on interest income earned on them.

Alpha Corporation would have to pay tax on income received from corporate bonds and preferred stocks at 35%, which means it's after tax income would be even lower than the quoted yields.