Assume that Will's marginal tax rate is 32% and his tax rate on dividends is 15%. If a dividend-paying stock (with no growth potential) pays a dividend yield of 8%, what interest rate must the corporate bond offer for Will to be indifferent between the two investments from a cash-flow perspective?

Question

Quizplus · Accepted Answer

To find the interest rate that makes Will indifferent between a dividend-paying stock and a corporate bond, we need to set the after-tax dividend yield equal to the after-tax interest rate.

After-tax dividend yield = Dividend yield * (1 - tax rate on dividends) 
After-tax dividend yield = 0.08 * (1 - 0.15) = 0.068

After-tax interest rate = Interest rate * (1 - marginal tax rate) 
0.068 = Interest rate * (1 - 0.32) 
Interest rate = 0.1 or 10%

Therefore, the corporate bond must offer an interest rate of 10% for Will to be indifferent between the two investments from a cash-flow perspective.

Assume That Will's Marginal Tax Rate Is 32% and His