Assume that Lavonia's marginal tax rate is 22 percent. If a city of Tampa bond pays 5.4 percent interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Question

Quizplus · Accepted Answer

To make Lavonia indifferent between the two bonds, the after-tax yield of the corporate bond must equal the yield of the tax-exempt city bond. The formula to calculate the equivalent taxable interest rate is: Tax-Exempt Interest Rate / (1 - Marginal Tax Rate). Plugging in the numbers: 5.4% / (1 - 0.22) = 5.4% / 0.78 = 6.923%, which rounds to 6.92%.

Assume That Lavonia's Marginal Tax Rate Is 22 Percent