Jackson has the choice to invest in city of Mitchell bonds or Sundial, Incorporated corporate bonds that pay 10 percent interest. Jackson is a single taxpayer who earns $55,000 annually. Assume that the city of Mitchell bonds and the Sundial, Incorporated bonds have similar risk. What interest rate would the city of Mitchell have to pay in order to make Jackson indifferent between investing in the city of Mitchell and the Sundial, Incorporated bonds for 2020? (Use tax rate schedule.)
A)7)80 percent
B)10.00 percent
C)8)00 percent
D)7)20 percent
E)None of the choices are correct

Question

Quizplus · Accepted Answer

The correct answer is A because the city of Mitchell would have to pay 7.80 percent interest in order to make Jackson indifferent between investing in the city of Mitchell and the Sundial, Incorporated bonds for 2020. This is because Jackson is in the 22% tax bracket, so he would pay 22% of the interest he earns on the city of Mitchell bonds in taxes. This means that he would only receive 7.80% of the interest he earns on the city of Mitchell bonds after taxes. Since he can earn 10% interest on the Sundial, Incorporated bonds tax-free, he would only be indifferent between the two investments if the city of Mitchell paid 7.80% interest.

Jackson Has the Choice to Invest in City of Mitchell