Assume that Will'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 a dividend yield of 8 percent, what interest rate must the corporate bond offer for Will to be indifferent between the two investments from a cash-flow perspective?

Question

Quizplus · Accepted Answer

To be indifferent, the after-tax yield from the bond must equal the after-tax yield from the dividend. The after-tax dividend yield is 8% * (1 - 0.15) = 6.8%. The bond's after-tax yield is the interest rate * (1 - 0.32). Solving for the interest rate gives 10%.

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