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

Question

Quizplus · Accepted Answer

The after-tax return on the dividend-paying stock is calculated as follows: 
8% x (1 - 0.15) = 6.8%
The after-tax return on the municipal bond (assuming it is tax-exempt) must also be 6.8% for Lucas to be indifferent between the two investments. Therefore, the bond must offer an interest rate of:

6.8% / (1 - 0.32) = 10.00%

However, as municipal bond interest is often tax-exempt, the answer is likely to be lower than 10%. The closest option is D) 6.80 percent.

Assume That Lucas's Marginal Tax Rate Is 32 Percent and His