Assume that John's marginal tax rate is 17 percent. If a city of Austin bond pays 6.6 percent interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?

Question

Quizplus · Accepted Answer

To find the required interest rate for the corporate bond, we need to consider the after-tax return on both bonds. 
For the city of Austin bond, the after-tax return would be:
6.6% x (1-0.17) = 5.47%
For John to be indifferent between the two bonds, the corporate bond must offer the same after-tax return of 5.47%. Thus, we can set up the equation: 
Before-tax corporate bond rate x (1-0.17) = 5.47%
Simplifying, we get:
Before-tax corporate bond rate = 6.59%
Therefore, the corporate bond would need to offer an interest rate of 6.59% for John to be indifferent between the two bonds. Choice B is the closest option.

Assume That John's Marginal Tax Rate Is 17 Percent