Question

A municipal bond you are considering as an investment currently pays a yield of 6.84 percent.

a. Calculate the tax equivalent yield if your marginal tax rate is 28 percent.
b. Calculate the tax equivalent yield if your marginal tax rate is 21 percent. (For all requirements, round your answers to 3 decimal places. (e.g., 32.161)

Answer 1

a.9.500%

b.8.658%

Step-by-step explanation:

The formula for computing tax equivalent yield is tax-free bond yield divided by the tax rate reciprocal.

Tax equivalent yield=tax free municipal bond yield rate/tax reciprocal

The tax reciprocal is 1-tax rate

for tax free municipal bond yield of 6.84% and the tax rate of 28%,the tax equivalent yield is computed thus:

tax equivalent yield=6.84%/(1-0.28)

=6.84%/0.72

=9.500%

At marginal tax rate of 21%,tax equivalent yield is computed thus:

Tax equivalent yield=6.84%/(1-0.21)

=6.84%/0.79

=8.658%