Question

Elizabeth is planning to invest $10,000 and is considering two alternatives: Alternative 1: City of Austin Municipal Bond yielding 5% interest Alternative 2: BBB Corporation bond yielding 8% interest Assuming she has a 25% marginal tax rate on ordinary income, the after-tax rate of return on the City of Austin Bond is % and the after-tax rate of return on the BBB Corporate bond is %.

Answer 1

The after-tax rate of return on the City of Austin Municipal Bond is 3.75%, while the after-tax rate of return on the BBB Corporation bond is 6%.

Step-by-step explanation:

The after-tax rate of return for the City of Austin Municipal Bond can be calculated as follows:

1. First, calculate the pre-tax interest earned on the bond by multiplying the initial investment amount ($10,000) by the interest rate (5%). This gives $500 in interest earned.
2. Next, calculate the amount of tax paid on the interest by multiplying the pre-tax interest by the marginal tax rate (25%). This gives $125 in tax paid.
3. Finally, subtract the tax paid from the pre-tax interest earned to find the after-tax interest earned. In this case, it is $500 - $125 = $375.

Therefore, the after-tax rate of return on the City of Austin Municipal Bond is $375 / $10,000 = 3.75%.

The after-tax rate of return for the BBB Corporation bond can be calculated in a similar manner, with a pre-tax interest of $800 and tax paid of $200. So, the after-tax interest earned is $800 - $200 = $600. Therefore, the after-tax rate of return on the BBB Corporation bond is $600 / $10,000 = 6%.