Question

Assume that Marsha is indifferent between investing in a city of Destin bond that pays 3.45 percent interest and a corporate bond that pays 6.95 percent interest. What is Marsha's marginal tax rate? Note: Do not round intermediate computations.

Answer 1

Marsha's marginal tax rate is 0%, indicating that she does not pay any taxes on her investment income.

Step-by-step explanation:

Marsha's marginal tax rate can be calculated by finding the difference in interest rates between the two bonds and dividing it by the difference in interest payments. Since Marsha is indifferent between the two bonds, the difference in interest rates is equal to the difference in pretax yields. Let's assume her marginal tax rate is denoted by 'T'.

1. The pretax yields of the two bonds are: 0.0345 for the municipal bond and 0.0695 for the corporate bond.
2. The pretax yield difference is 0.0695 - 0.0345 = 0.035 or 3.5%.
3. The difference in interest payments is the 6.95% corporate bond rate minus the 3.45% municipal bond rate, which is 0.0695 - 0.0345 = 0.035 or 3.5%.
4. To find Marsha's marginal tax rate, we equate the pretax yield difference to the after-tax yield difference: 0.035(1 - T) = 0.035.
5. Solving for T, we get: 1 - T = 1, so T = 0 or 0%.

Therefore, Marsha's marginal tax rate is 0%, indicating that she does not pay any taxes on her investment income.