Question

2. Melinda invests $200,000 in a City of Heflin bond that pays 6 percent interest. Alternatively, Melinda could have invested the $200,000 in a bond recently issued by Surething Inc., that pays 8 percent interest and has risk and other nontax characteristics similar to the City of Heflin bond. Assume Melinda’s marginal tax rate is 25 percent. (Leave no cells blank - be sure to enter "0" wherever required.)

a. What is her after-tax rate of return for the City of Heflin bond?

b. How much explicit tax does Melinda pay on the City of Heflin bond?

c. How much implicit tax does she pay on the City of Heflin bond?

d. How much explicit tax would she have paid on the Surething Inc. bond?

e. What is her after-tax rate of return on the Surething Inc. bond?

Answer 1

a.)

After-tax rate of return for the City of Heflin bond

$ 12,000

=200000*6%

Since, City of Helfin bond interest is tax exempt, hence after tax return will be equal to pre tax return of $12,000.

b.)	Explicit tax does Melinda pay on the City of Heflin bond	$ 0
c.)	Implicit tax does she pay on the City of Heflin bond	$ 4,000	=(200000*8%)-(200000*6%)
	(Reduction in before tax yield)
d.)	Explicit tax would she have paid on the Surething Inc. bond	$ 4,000	=200000*8%*25%
e.)	After-tax rate of return on the Surething Inc. bond	$ 12,000	=(200000*8%)-4000