Question

Dana intends to invest $80,000 in either a treasury bond or a corporate bond. the treasury bond yields 5 percent before tax, and the corporate bond yields 6 percent before tax. assume dana's federal marginal rate is 24 percent and she itemizes deductions.

required:
assuming dana's marginal state rate is 5 percent, which of the two options should she choose?

Answer 1

After considering federal and state taxes, Dana should invest in the corporate bond, which provides a higher after-tax yield than the Treasury bond.

Step-by-step explanation:

To determine whether Dana should invest in a Treasury bond or a corporate bond, we must consider the after-tax yield of each investment. The Treasury bond yields 5% before tax, while the corporate bond yields 6%. However, Dana’s federal marginal rate is 24%, and her marginal state rate is 5%. Treasury bond interest is exempt from state taxes, but corporate bond interest is not.

Calculating after-tax yield for the Treasury bond: $80,000 x 5% = $4,000 (before federal tax). After federal tax: $4,000 - ($4,000 x 24%) = $3,040.

For the corporate bond, since state tax applies: $80,000 x 6% = $4,800 (before tax). After federal and state tax: $4,800 - ($4,800 x (24% + 5%)) = $3,192.

Despite a higher pre-tax yield, the after-tax yield of the corporate bond is higher. Therefore, Dana should choose the corporate bond for a better return on investment after considering taxes.