Final answer:
To compare the yields of a tax-free and a taxable bond, you must calculate the taxable equivalent yield for each tax bracket. Individuals in lower tax brackets would benefit more from the tax-free bond, while those in higher brackets would get a better return from the taxable bond.
Step-by-step explanation:
The question concerns comparing the yields of a tax-free bond versus a taxable bond to determine which offers a higher return for individuals in various tax brackets. In order to make a fair comparison, one must calculate the taxable equivalent yield of the tax-free bond. This is calculated by dividing the tax-free yield by one minus the individual's tax rate.
For example, if the tax-free bond yields 7%, to find the equivalent taxable yield for someone in the 24% tax bracket, the calculation would be 7% / (1 - 0.24) = 9.21%. Therefore, the tax-free bond would be a better investment than the taxable bond yielding 9.75% for anyone in a tax bracket lower than 24%, as the equivalent yield would be less than 9.75% after taxes.
However, individuals in tax brackets higher than 24% would receive a taxable equivalent yield on the tax-free bond that is lower than the taxable bond's 9.75%. For example, someone in the 32% tax bracket would calculate it as 7% / (1 - 0.32) = 10.29%, which is less than the taxable bond's yield when adjusted for taxes.
Therefore, based on this calculation, individuals in tax brackets a (10%), b (12%), c (22%), and d (24%) would earn a higher return with the tax-free bond, while individuals in tax brackets e (32%), f (35%), and g (37%) would earn a higher return with the taxable bond.