Question

Kim Davis is in the 40 percent tax bracket, she is considering investing in HCA (taxable) bonds that carry a 12 percent interest rate. What is her after-tax yield (interest rate) on the bonds? Suppose Twin Cities Memorial Hospital has issued tax-exempt bonds that have an interest rate of 6 percent. With all else the same, should Kim buy the HCA or the Twin Cities bonds? With all else the same, what interest rate on the tax-exempt Twin Cities bonds would make Kim indifferent between these bonds and the HCA bonds?

Answer 1

Part (a): After tax yield- Interest*(1 -tax rate) 12*-0.4) After tax yield-7.2% Part (b): Twin cities (non-taxable) bond interest rate Part (c): HCA (taxable) bonds the Twin cities bonds should give interest equal to after tax yield on Kim should buy HCA (taxable) bonds as their after tax yield is more than In order to make Kim indifferent between Twin cities (non-taxable) bonds and HCA bonds that is interest rate on Twin cities bonds should be 7.2%