Question

Aditi Patel currently hold tax exempt bonds of Good Samaritan Healthcare that pay 7 percent interest. She is in the 40 percent tax bracket. Her broker wants her to buy some Beverly Enterprises taxable bond that will be issued next week. With all else the same, what rate must be set on the Beverly bonds to make Aditi interested in make a switch?

Answer 1

Interest Rate on Good Samaritan Healthcare tax exempt bond = 7% annually

Tax Rate = 40%

Beverly Enterprise's Bonds are taxable bond with interest rate i,

So to make a switch to Beverly's Bonds it's after tax return should be equal to or greater than tax exempt bond,

So,

i(1 - 0.40) = 0.07

i = 11.67%

So,

Interest Rate on Beverly Enterprise's Bond must be at least 11.67%

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