Question

Calculate the​ after-tax return of a 6.02 ​percent, 20-year,​ A-rated corporate bond for an investor in the 10 percent marginal tax bracket. Compare this yield to a 4.49 ​percent, 20-year,​ A-rated, tax-exempt municipal bond and explain which alternative is better. Repeat the calculations and comparison for an investor in the 35 percent marginal tax bracket.

Answer 1

1. At 10%, the Corporate bond is higher @5.12 and better while at 35%, the Municipal bond is higher and better @4.49%

Step-by-step explanation:

First step: Calculating the after-tax return for 6.02%, 20 years and 10% marginal tax bracket

The formula for this after-tax return

= Interest rate x (1- Tax rate)

= 6.02% x (1- 10%)

= 6.02% x (1-0.15)

= 5.12%

The tax rate of the tax exempt municipal bond = 4.49%

The tax rate for the A-rated corporate bond is higher at 5.12% than the tax-exempt municipal bond. Therefore the Corporate bond is better.

First 2: Calculating the after-tax return for 6.02%, 20 years and 35% marginal tax bracket

The formula for this after-tax return

= Interest rate x (1- Tax rate)

= 6.02% x (1- 35%)

= 6.02% x (1-0.35)

= 3.91%

The tax rate of the tax exempt municipal bond = 4.49%

The tax rate for the tax-exempt municipal bond is lower at 3.91% than the A-rated corporate bond . Therefore municipal bond will be better.