Question

1.

Dana intends to invest $62,000 in either a Treasury bond or a corporate bond. The Treasury bond yields 5 percent before tax and the corporate bond yields 6 percent before tax.

a-1. Assuming Dana’s federal marginal rate is 24 percent and her marginal state rate is 5 percent, which of the two options should she choose? Assume that Dana itemizes deductions.

    

Corporate bond

Treasury bond

a-2. How much interest after-tax would Dana earn by investing in the corporate bond?  (Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)

    

b-1. If she were to move to another state where her marginal state rate would be 10 percent, which of the two options should she choose? Assume that Dana itemizes deductions.

    

Corporate bond

Treasury bond

b-2. How much interest after-tax would Dana earn by investing in the corporate bond as per requirement b-1? (Do not round intermediate calculations and round your final answer to the nearest whole dollar amount.)

    

Answer 1

a-1. When the state rate is 5 percent, Dana would achieve the following returns from the Treasury bond or the corporate bond:

The Treasury bond yields $2,356 or 62,000 × [0.05 × (1 − 0.24)] after tax. The corporate bond yields $2,685.84 or 62,000 × [0.06 × (1 − 0.24 − 0.05(1 − 0.24))] after tax. Note that the actual state rate is reduced by 24% to allow for the deductibility of state income taxes on the federal income tax return. Thus, she should choose the corporate bond

a-2. 2,685.84

b-1 When the state rate is 10%, Dana would achieve the following returns from the Treasury bond or the corporate bond:

The Treasury bond would still yield $2,356 or 62,000 × [0.05 × (1 − 0.24)] after tax because state rates don’t affect after tax returns from Treasury bonds. The corporate bond yields $2,544.48 or 62,000 × [0.06 × (1 − 0.24 − 0.10(1 − 0.24))] after tax. Again, note that the actual state rate is reduced by 25% to allow for the deductibility of state income taxes on the federal income tax return. If Dana’s state tax rate increases to 10%, corporate bonds are still superior to Treasury bonds.

b-2 - 2,544.48