Question

Curtis invests $225,000 in a city of Athens bond that pays 4.25% interest. Alternatively, Curtis could have invested the $225,000 in a bond recently issued by Initech, Inc. that pays 5.50% interest with similar risk as the city of Athens bond. Assume that Curtis's marginal tax rate is 24%. How much implicit tax would Curtis pay on the city of Athens bond?

a. $9,562.50
b. $466.00
c. $366.00
d. $2,812.50
e. None of the choices are correct.

Answer 1

The implicit tax Curtis would pay on the city of Athens bond is the difference between the after-tax interest from the Initech bond and the tax-free interest from the city bond, which is \\$157.50. None of the provided answer choices are correct.

Step-by-step explanation:

To calculate the implicit tax that Curtis would pay on the city of Athens bond, we need to compare the after-tax returns he would get from both the Athens bond and the Initech bond. The Athens bond pays 4.25% interest, so Curtis would earn \\$225,000 \times 0.0425 = \\$9,562.50 in interest before tax. Because municipal bonds are typically exempt from federal taxes, Curtis would not pay taxes on the interest from the city of Athens bond. If Curtis invested in the Initech bond, which pays 5.50% interest, he would earn \\$225,000 \times 0.0550 = \\$12,375 before tax. However, Curtis is in the 24% marginal tax bracket, so his after-tax return from the Initech bond would be \\$12,375 \times (1 - 0.24) = \\$9,405.00.

The implicit tax paid on the city of Athens bond is the difference between the after-tax interest of the Initech bond and the tax-free interest of the city of Athens bond: \\$9,562.50 - \\$9,405.00 = \\$157.50. Since this amount is not one of the provided options, the correct answer is 'e. None of the choices are correct.'