Assume that Keisha's marginal tax rate is 40% and her tax rate on dividends is 15%. If a city of Atlanta bond pays 7.65% interest, what dividend yield would a dividend-paying stock (with no growth potential) have to offer for Keisha to be indifferent between the two investments from a cash-flow perspective?

Question

Quizplus · Accepted Answer

To find the dividend yield required for Keisha to be indifferent between the two investments, we need to set up the after-tax cash flows for each investment and solve for the unknown dividend yield.

For the bond, the after-tax cash flow would be:

$765 (annual interest) x (1 - 0.4) = $459

For the dividend-paying stock, the after-tax cash flow would be:

Dividend yield x (1 - 0.15) = Dividend yield x 0.85

Set up an equation with the two after-tax cash flows equal to each other:

$459 = Dividend yield x 0.85

Divide both sides by 0.85:

Dividend yield = $459 / 0.85 = 540

So, the required dividend yield is 9%. Therefore, the best choice is (D).

Assume That Keisha's Marginal Tax Rate Is 40% and Her