Question

5. Mr. G has $15,000 to invest. He is undecided about putting the money into tax-exempt municipal bonds paying 7 percent annual interest or corporate bonds paying 9.5 percent annual interest. The two investments have the same risk. a) Which investment should Mr. G make if his marginal tax rate is 33 percent? b) Would your conclusion change if Mr. G’s marginal tax rate is only 15%?

Answer 1

a. Municipal bond

b. Yes. To Corporate Bond

Step-by-step explanation:

Answer 2

a. Municipal bond

b. Yes. To Corporate Bond.

Step-by-step explanation:

Municipal bonds are tax exempt so the better option will be the one offering a higher return after it is adjusted for tax.

a. Corporate after-tax rate = 9.5% * ( 1 - 33%)

= 0.06365‬

= 6.4%

Municipal rate is higher at 7% and so is a better option.

b. Corporate after-tax rate = 9.5% * ( 1 - 15%)

= 0.08075‬

= 8.08%

Corporate bond return is now higher than Municipal bond so is a better option.