Corporate bonds issued by Johnson Corporation currently yield 8%. Municipal bonds of equal risk currently yield...

Corporate bonds issued by Johnson Corporation currently yield 8%. Municipal bonds of equal risk currently yield 5.5%. At what tax rate would an investor be indifferent between these two bonds? Round your answer to two decimal places.

Solutions

Expert Solution

For the investor to be indifferent, the after-tax yield on the Johnson Corporation bond should equal the yield on the municipal bond.

This is because municipal bonds are tax free.

After-tax yield = pretax yield * (1 - T)

where t = tax rate

8% * (1 - T) = 5.5%

T = 1 - (5.5% / 8%)

T = 31.25%

At a tax rate of 31.25%, an investor would be indifferent

jeff jeffy answered 2 years ago

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