Question

A municipal bond you are considering as an investment currently pays a yield of 6.82 percent.

a. Calculate the tax equivalent yield if your marginal tax rate is 28 percent.
b. Calculate the tax equivalent yield if your marginal tax rate is 21 percent.

Answer 1

A	B	C	D	E	F	G	H	I
2
3		Municipal bonds are tax free, therefore tax equivalent yield is calculated to
4		compare the bond with normal bonds which are not tax free.
5
6		Tax Equivalent Yield	=Yield of municipal bond / (1-Tax Rate)
7
8		a)
9		Using the following data:
10		Tax rate	28%
11		Yield on municipal bond	6.82%
12
13		Tax Equivalent Yield	=Yield of municipal bond / (1-Tax Rate)
14			9.47%	=D11/(1-D10)
15
16		Hence Tax Equivalent Yield is	9.47%
17
18		b)
19		Using the following data:
20		Tax rate	21%
21		Yield on municipal bond	6.82%
22
23		Tax Equivalent Yield	=Yield of municipal bond / (1-Tax Rate)
24			8.63%	=D21/(1-D20)
25
26		Hence Tax Equivalent Yield is	8.63%
27