Question

James invests $100,000 in a city of Athens bond that pays 8% interest. Alternatively, James could have invested the $100,000 in a bond recently issued by HighTech, Inc. that pays 10% interest with similar risk as the city of Athens bond. Assume that James’s marginal tax rate is 25%. Which bond should James should choose and why?

Answer 1

The James should choose city Athens bond because the amount of interest earned in city Athens bond is more.

Step-by-step explanation:

Given:

Amount invested by James = $100,000

Rate of interest offered by city Athens bond = 8%

also,

rate of interest paid by the HighTech Inc. = 10%

Marginal tax rate = 25%

Now,

The amount of interest earned from the city Athens bonds

= Amount invested × Interest rate

= $100,000 × 0.08

= $8,000

and,

The amount of interest earned from the HighTech Inc bonds

= Amount invested × Tax rate

= The amount of interest earned from the city Athens bonds

= $100,000 × 0.10

= $10,000

Now,

the actual amount received after the marginal tax

= Interest earned - Marginal tax

= $10,000 - 0.25 × $10,000

= $7,500

Since,

the amount of interest earned in city Athens bond is more

Hence,

The James should choose city Athens bond