Zeinab is very conservative with her money and has $100,000 to invest. She is evaluating two...

Zeinab is very conservative with her money and has $100,000 to invest. She is evaluating two alternatives - a municipal bond issued by the state of Ohio that pays 4% interest and a bond issued by Sears Corporation that pay 14%. Zeinab is in the 35% marginal tax bracket and overall she pays an average 25% tax rate.

a) After taxes how much will each bond pay Zeinab per year?

b) What attributes of the bonds should Zeinab consider when evaluating these two investment alternatives? Which bond should Zeinab invest her money in? Why?

PLEASE SHOW FULL WORK ON EXCEL. THANK YOU.

Solutions

Expert Solution

We shall use Marginal tax bracket as bond investment earnings shall be over and above the regular income of Zainab.

Using excel to calculate after tax returns:

After tax returns = pretax returns*(1-tax rate)

		Tax	After Tax
Municipal Bond	4.00%	0.00%	4.00%
Sear's Corp	14.00%	35.00%	9.10%

The attribute that Zainab shall consider is the total after tax returns and the risk of bonds. Since the municipal bonds are tax free, they may be a good option. The municipal bonds are less risky than a corporate bond. However Sear's corp bonds pay a higher rate of interest on an after tax basis. Hence Zainab shall invests in Sear's corporation bonds.

jeff jeffy answered 1 year ago

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