Assume that Shavonne's marginal tax rate is 37 percent and her tax rate on dividends is 10 percent. If a corporate bond pays 6.8 percent interest, what dividend yield would a dividend-paying stock (with no growth potential)have to offer for Shavonne to be indifferent between the two investments from a cash-flow perspective?

Question

Quizplus · Accepted Answer

To find the dividend yield that would make Shavonne indifferent between the bond and stock investments, we need to set their after-tax cash flows equal to each other.

For the bond investment, the after-tax cash flow would be: 
Annual interest payment * (1 - Marginal tax rate) 
= 0.068 * (1 - 0.37) 
= 0.04276 or 4.276%

For the dividend-paying stock investment, the after-tax cash flow would be: 
Dividend yield * (1 - Dividend tax rate) 
= Dividend yield * (1 - 0.1) 
= 0.9 * Dividend yield

Setting the two after-tax cash flows equal, we can solve for the dividend yield: 
0.04276 = 0.9 * Dividend yield 
Dividend yield = 0.04276 / 0.9 
Dividend yield = 0.04751 or 4.751%

Therefore, the dividend yield that would make Shavonne indifferent between the bond and stock investments is approximately 4.76%, which corresponds to choice B).

Assume That Shavonne's Marginal Tax Rate Is 37 Percent and Her