Final answer:
To find the equivalent taxable interest rate of the tax-exempt New York bond for Fergie, we use the equation: Equivalent Taxable Interest Rate = Tax-Exempt Yield / (1 - Marginal Tax Rate). The New York bond would need to offer a 5.86% interest rate to be equivalent after taxes to the Surething Inc. bond, assuming Fergie's 30 percent tax rate.
Step-by-step explanation:
The student is asking about how to compare the interest rates of different bonds when accounting for taxes. To make Fergie indifferent between the State of New York bond at 4.1 percent and the Surething Inc. bond at 6.8 percent, we need to adjust the municipal bond rate for Fergie's tax rate. Since municipal bonds are often tax-free, the yield one would require from a taxable bond to be equivalent after taxes is calculated by dividing the tax-exempt yield by (1 - marginal tax rate).
Equivalent Taxable Interest Rate = Tax-Exempt Yield / (1 - Marginal Tax Rate)
In Fergie's case, using the formula will give us:
Equivalent Taxable Interest Rate = 4.1% / (1 - 0.30)
Therefore, for Fergie to be indifferent between the two bonds, considering her 30 percent tax rate, the State of New York bond would need to offer an interest rate calculated as follows:
Equivalent Taxable Interest Rate = 4.1% / (1 - 0.30) = 4.1% / 0.70 = 5.86%
Since the Surething Inc. bond offers 6.8 percent, we see that even after adjusting for taxes, the Surething Inc. bond has a higher after-tax yield than the New York bond's current 4.1% rate.