Assume that Bill's marginal tax rate is 42 percent. If corporate bonds pay 6 percent interest, what interest rate would a municipal bond have to offer for Bill to be indifferent between the two bonds? (Do not round your final answer.)

Question

Quizplus · Accepted Answer

To find the equivalent interest rate for a municipal bond that would make Bill indifferent between investing in a corporate bond and a municipal bond, we use the formula for after-tax return on the corporate bond and set it equal to the return on the municipal bond. The after-tax return on the corporate bond is the interest rate times (1 - marginal tax rate). So, for a 6 percent corporate bond and a 42 percent tax rate, the calculation is 6% * (1 - 0.42) = 3.48%. Therefore, a municipal bond would need to offer an interest rate of 3.48% for Bill to be indifferent between the two.

Assume That Bill's Marginal Tax Rate Is 42 Percent