Curtis invests $250,000 in a city of Athens bond that pays 7 percent interest.Alternatively, Curtis could have invested the $250,000 in a bond recently issued by Initech, Inc.that pays 9 percent interest with similar risk as the city of Athens bond.Assume that Curtis's marginal tax rate is 24 percent. If Curtis invested in the Initech, Inc.bonds, what would be his after-tax rate of return from this investment?

Question

Quizplus · Accepted Answer

If Curtis invested in the city of Athens bond, he would earn:
$250,000 x 0.07 = $17,500 in interest.

If Curtis invested in the Initech, Inc. bond, he would earn:
$250,000 x 0.09 = $22,500 in interest.

However, since Curtis's marginal tax rate is 24%, he will have to pay taxes on the interest income.

For the city of Athens bond, his after-tax rate of return would be:
$17,500 x (1 - 0.24) / $250,000 = 0.0468 or 4.68%.

For the Initech, Inc. bond, his after-tax rate of return would be:
$22,500 x (1 - 0.24) / $250,000 = 0.0684 or 6.84%.

Therefore, Curtis's after-tax rate of return from investing in the Initech, Inc. bond is higher than the after-tax rate of return from investing in the city of Athens bond.

Curtis Invests $250,000 in a City of Athens Bond That