Question

Andy is considering investing $5,000 into one of three investments. He can invest in corporate stock that will pay dividends of 5% per year. He can purchase corporate bonds that pay 6%. Or, he can invest in tax-exempt securities that will pay 4% per year. Andy is in the 33% marginal tax bracket, and the dividends will be taxed at 15%. Match the investment to its respective after-tax return.

A) Corporate stock
B) Corporate bonds
C) Tax-exempt securities

Answer 1

After calculating the after-tax returns of corporate stock (A: $212.50), corporate bonds (B: $201), and tax-exempt securities (C: $200), it is clear that corporate stock provides the highest after-tax return for Andy, assuming all other factors are equal.

Step-by-step explanation:

Andy is considering investing $5,000 into one of three investments: corporate stock with 5% dividends, corporate bonds with a 6% return, or tax-exempt securities with a 4% return. Since Andy is in the 33% tax bracket, we need to calculate the after-tax return for each investment to determine which is best.

Corporate stock: The dividends are taxed at 15%. Total return: $5,000 x 5% = $250, After-tax return: $250 - ($250 x 15%) = $212.50.
Corporate bonds: The interest is taxable at the marginal tax rate. Total return: $5,000 x 6% = $300, After-tax return: $300 - ($300 x 33%) = $201.
Tax-exempt securities: Zero tax on the return. Total return and After-tax return: $5,000 x 4% = $200.

Matching the investments to their respective after-tax returns:
A) Corporate stock: $212.50
B) Corporate bonds: $201
C) Tax-exempt securities: $200