Question

Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners. If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return

Answer 1

Investor's before required rate of return is 12.5%

Step-by-step explanation:

The investor required return is the pretax return on the investment before applying the tax rate of 28%.

The pretax rate of return on the investment can be computed using the after tax return formula below by changing the subject of the formula to pretax rate of return;

After rate of return=pretax rate of return*(1-t)

t is the tax rate of 28% or 0.28

pretax rate of return is unknown

after tax rate of return is 9%

pretax rate of return=after tax rate of return/(1-t)

pretax rate of return=9%/(1-0.28)

pretax rate of return=9%/0.72

pretax rate of return =12.5%