Assume that Larry's marginal tax rate is 24 percent. If corporate bonds pay 7.8 percent interest, what interest rate would a municipal bond have to offer for Larry to be indifferent between the two bonds?

Question

Quizplus · Accepted Answer

To find the interest rate that the municipal bond would have to offer, we need to set the after-tax return on the corporate bond equal to the after-tax return on the municipal bond. 
After-tax return on Corporate bond = 7.8% * (1-0.24) = 5.93%
Let x be the interest rate on the municipal bond. 
After-tax return on Municipal bond = x * (1-0) = x%
Setting the two after-tax returns equal to each other: 
5.93% = x%
Therefore, the interest rate on the municipal bond would have to be 5.93% for Larry to be indifferent between the two bonds.

Assume That Larry's Marginal Tax Rate Is 24 Percent