Question

You are comparing two investments. A corporate bond earns 8 percent interest and is subject to federal tax at your rate of 25 percent. A government bond earns 5.5 percent interest and is tax-exempt. After considering taxes, you decide the corporate bond is still the better investment. What is the corporate bond’s rate of interest earnings after taxes?

Answer 1

The corporate bond's rate of interest earnings after taxes is 6 percent, calculated by taking the interest rate of 8 percent and adjusting for a 25 percent federal tax rate.

Step-by-step explanation:

The question asks for the after-tax yield of a corporate bond that earns 8 percent interest and is subject to a 25 percent federal tax rate. To calculate the after-tax yield, you multiply the interest rate by (1 - tax rate). In this case, it would be 8 percent × (1 - 0.25), which equals 6 percent. Therefore, the corporate bond's rate of interest earnings after taxes is 6 percent.

Answer 2

After considering a 25 percent federal tax on an 8 percent corporate bond interest rate, the after-tax interest earnings are 6 percent. This is higher than the tax-exempt 5.5 percent interest earned by the government bond, making the corporate bond the better investment option.

Step-by-step explanation:

The corporate bond you are considering earns an interest of 8 percent, but as it is subject to a federal tax rate of 25 percent, you need to calculate the after-tax yield to compare it with the tax-exempt government bond. The after-tax interest rate of the corporate bond can be found by subtracting the tax paid from the interest earned. The formula for the after-tax yield is Interest Earned × (1 - Tax Rate).

Thus, the after-tax interest earnings on the corporate bond are 6 percent. Given that the government bond earns 5.5 percent interest tax-exempt, the corporate bond's after-tax earnings are still higher than the government bond's earnings.