Assume that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential) pays an 8% dividend yield, whatinterest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments from a cash-flow perspective?

Question

Quizplus · Accepted Answer

Lucas' after-tax return on the dividend-paying stock is calculated as follows:

After-tax return = Dividend yield x (1 - tax rate on dividends) 
= 8% x (1 - 0.15) 
= 6.8%

Therefore, from a cash-flow perspective, Lucas would be indifferent between the stock and a municipal bond if the bond offered a yield of 6.8%. Therefore, the answer is B.

Assume That Lucas' Marginal Tax Rate Is 30% and His