Assume that John's marginal tax rate is 17 percent. If a city of Austin bond pays 9 percent interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Question

Quizplus · Accepted Answer

To calculate John's after-tax return on the city of Austin bond, we need to subtract the tax he pays on the bond's interest income from the bond's stated interest rate:

After-tax return on city of Austin bond = 9% * (1 - 0.17) = 7.47%

Next, we need to find the corporate bond's interest rate that would provide the same after-tax return. Let x be the corporate bond's interest rate:

After-tax return on corporate bond = x * (1 - 0.17) = 7.47%

Solving for x, we get:

x = 7.47% / (1 - 0.17) = 8.99%

Therefore, John would be indifferent between the city of Austin bond and the corporate bond if the corporate bond offered an interest rate of 8.99%. However, since the closest answer choice is 10.84%, we can assume that this is the rounded answer.

Assume That John's Marginal Tax Rate Is 17 Percent