Question

1.Matt recently deposited $30,000 in a savings account paying a guaranteed interest rate of 4 percent for the next 10 years. If Matt expects his marginal tax rate to be 22 percent for the next 10 years, how much interest will he earn after-tax after the fourth year of his investment if he withdraws enough cash every year to pay the tax on the interest he earns?  

2. Dana intends to invest $25,000 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. Dana’s federal marginal rate is 25 percent and her marginal state rate is 5 percent. What is the amount by which the yield on the corporate bond exceeds the yield on the Treasury bond.  Assume that Dana itemizes her deductions and that any state income tax would be fully deductible.  

3.Hayley recently invested $40,000 in a public utility stock paying a 3 percent annual dividend. If Hayley reinvests the annual dividend she receives net of any taxes owed on the dividend, how much will her investment be worth in four years if the dividends paid are qualified dividends? (Hayley’s marginal income tax rate is 32 percent.)

Answer 1

1.

Year	Opening Balance	Interest @ 4%	Tax @ 22%	Net Interest	Closing Balance
1	30,000.00	1,200.00	264.00	936.00	30,936.00
2	30,936.00	1,237.44	272.24	965.20	31,901.20
3	31,901.20	1,276.05	280.73	995.32	32,896.52
4	32,896.52	1,315.86	289.49	1,026.37	33,922.89

Interest earned after 4 years = 33,922.89 - 30,000 = 3,922.89

2.

Calculation of Net Yield after Tax
	Particulars	Treasury Bond	Corporate Bond
A	Investment Value	25000	25000
B	Yield before tax (interest)	1250	1500
		(25000*5%)	(25000*6%)
C	State Tax @ 5% on Interest	62.5	75
D	Interest taxable federal tax (B-C)	1187.5	1425
E	Federal Tax @ 25%	296.875	356.25
F	Total Tax (Federal + State)	359.375	431.25
G	Yield after taxes (B-F)	890.625	1068.75

Amount by which corporate bond yield is higher = 1068.75 - 890.625 = 178.125

3. Annual after tax return = 3 (1-0.32) = 2.04%

Investment Value after 4 years = 40000*(1+0.0204)^4 = 43,365.24