Question 1

Assume that Javier is indifferent between investing in a city of El Paso bond that pays 5 percent interest and a corporate bond that pays 6.25 percent interest. What is Javier's marginal tax rate?

Accepted Answer

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Question 2

Assume that Shavonne's marginal tax rate is 37 percent and her tax rate on dividends is 15 percent. If a corporate bond pays 10.20 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?

Accepted Answer

Shavonne's after-tax yield on the corporate bond would be:
10.20% x (1 - 0.37) = 6.43%
For a dividend-paying stock with no growth potential to be equally attractive, it must provide a dividend yield of:
6.43% / (1 - 0.15) = 7.56% To compare two investments, we need to find their after-tax cash flows.

For the corporate bond paying 10.20 percent interest:

After-tax yield = (1 - Marginal tax rate) * coupon rate 
After-tax yield = (1 - 0.37) * 0.102 = 0.06417 or 6.417%

For the dividend-paying stock with no growth potential:

After-tax yield = Dividend yield * (1 - Dividend tax rate) 
0.0654 = Dividend yield * (1 - 0.15) 
Dividend yield = 0.0766 or 7.56%

Since the after-tax yield of the dividend-paying stock is higher than the after-tax yield of the bond, Shavonne would be indifferent between the two investments.

Question 3

Assume that Javier is indifferent between investing in a city of El Paso bond that pays 3.05 percent interest and a corporate bond that pays 4.4 percent interest. What is Javier's marginal tax rate?

Accepted Answer

Javier's marginal tax rate can be calculated using the formula: Tax Rate = 1 - (Municipal Bond Rate / Corporate Bond Rate). Substituting the given rates: 1 - (3.05% / 4.4%) = 1 - 0.6932 = 0.3068 or 30.68%.

Question 4

Assume that Will's marginal tax rate is 35 percent and his tax rate on dividends is 15 percent. If a dividend-paying stock (with no growth potential)pays a dividend yield of 7 percent, what interest rate must the corporate bond offer for Will to be indifferent between the two investments from a cash-flow perspective?

Accepted Answer

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Question 5

Assume that Marsha is indifferent between investing in a city of Destin bond that pays 6 percent interest and a corporate bond that pays 8 percent interest. What is Marsha's marginal tax rate?

Accepted Answer

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Question 6

Assume that Juanita is indifferent between investing in a corporate bond that pays 8.40 percent interest and a stock with no growth potential that pays a 6.30 percent dividend yield. Assume that the tax rate on dividends is 15 percent. What is Juanita's marginal tax rate?(Do not round intermediate computations.)

Accepted Answer

To find Juanita's marginal tax rate, we need to equate the after-tax returns of both investments. The after-tax return on the bond is 8.40% * (1 - marginal tax rate). The after-tax return on the stock is 6.30% * (1 - 0.15). Setting these equal gives: 8.40% * (1 - marginal tax rate) = 6.30% * 0.85. Solving for the marginal tax rate gives approximately 36.25%.

Question 7

Assume that Juanita is indifferent between investing in a corporate bond that pays 10.20 percent interest and a stock with no growth potential that pays a 6 percent dividend yield. Assume that the tax rate on dividends is 15 percent. What is Juanita's marginal tax rate?

Accepted Answer

Juanita is indifferent between a 10.20% interest from a bond and a 6% dividend yield after tax. The after-tax yield on the dividend is 6% because dividends are taxed at 15%, meaning she keeps 85% of the dividend yield. To find the equivalent pre-tax yield on the dividend that matches the bond's interest rate, we set up the equation: 0.85 * Pre-tax yield = 6%. Solving for the pre-tax yield gives us 7.0588%. This means that if Juanita were taxed at her marginal rate on a 7.0588% yield, she would receive the same after-tax income as from the 6% dividend yield. Since the bond pays 10.20% and is equivalent in after-tax terms to a 7.0588% yield, her marginal tax rate must be such that 10.20% after tax is equivalent to a 7.0588% yield. The marginal tax rate that equates these two yields is 50%, as it reduces the 10.20% to 7.0588% after tax.

Question 8

Assume that Keisha's marginal tax rate is 37 percent and her tax rate on dividends is 20 percent. If a city of Atlanta bond pays 6.56 percent interest, what dividend yield would a dividend-paying stock (with no growth potential)have to offer for Keisha to be indifferent between the two investments from a cash-flow perspective?

Accepted Answer

To be indifferent, the after-tax yield from both investments should be equal. The after-tax yield from the bond is 6.56% (since municipal bonds are typically tax-free). For the stock, the after-tax yield is the dividend yield times (1 - 0.20). Setting these equal gives: Dividend Yield * (1 - 0.20) = 6.56%, solving gives Dividend Yield = 8.20%.

Question 9

Assume that Lavonia's marginal tax rate is 22 percent. If a city of Tampa bond pays 7.6 percent interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Accepted Answer

The correct answer is E.The after-tax interest rate on the city of Tampa bond is 7.6% * (1 - 22%) = 5.95%. To be indifferent between the two bonds, the corporate bond must offer an after-tax interest rate of 5.95%. The before-tax interest rate on the corporate bond is 5.95% / (1 - 22%) = 7.6%.

Question 10

Assume that Larry's marginal tax rate is 24 percent. If corporate bonds pay 10 percent interest, what interest rate would a municipal bond have to offer for Larry to be indifferent between the two bonds?

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Question 11

Assume that Lavonia's marginal tax rate is 22 percent. If a city of Tampa bond pays 5 percent interest, what interest rate would a corporate bond have to offer for Lavonia to be indifferent between the two bonds?

Accepted Answer

To find the equivalent taxable interest rate that would make Lavonia indifferent between a tax-exempt bond (like a municipal bond from the city of Tampa) and a taxable bond (like a corporate bond), we use the formula: Taxable Interest Rate = Tax-Exempt Interest Rate / (1 - Marginal Tax Rate). Plugging in Lavonia's details: 5% / (1 - 0.22) = 5% / 0.78 ≈ 6.41%. Since none of the provided options matches this calculation, the correct answer is E) None of the choices are correct.

Question 12

Assume that Keisha's marginal tax rate is 37 percent and her tax rate on dividends is 15 percent. If a city of Atlanta bond pays 7.65 percent interest, what dividend yield would a dividend-paying stock (with no growth potential)have to offer for Keisha to be indifferent between the two investments from a cash-flow perspective?

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Question 13

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?

Accepted Answer

Lucas's after-tax dividend yield = (1 - tax rate on dividends) x dividend yield
= (1 - 0.15) x 0.08
= 0.068

To be indifferent between the dividend-paying stock and a municipal bond, Lucas would require the after-tax yield on the municipal bond to be equal to 0.068.
Let x be the interest rate on the municipal bond.
Lucas's after-tax yield on the municipal bond = (1 - marginal tax rate) x x
= (1 - 0.32) x x
= 0.68x

Therefore, 0.68x = 0.068
x = 0.068/0.68
x = 0.10 or 10%

Therefore, the municipal bond would have to offer an interest rate of 10% for Lucas to be indifferent between the two investments from a cash-flow perspective. Lucas's after-tax return on the dividend-paying stock would be:
8% x (1-15%) = 6.8%
To find the interest rate at which Lucas would be indifferent between the municipal bond and the dividend-paying stock, we need to set the after-tax return of the bond equal to 6.8%. 
Let x be the interest rate of the municipal bond. Then, Lucas's after-tax return on the bond would be:
x x (1-32%) = 0.68
0.68 = 0.68x
x = 1 (or 100%) 
Therefore, the municipal bond would have to offer a 6.8% interest rate for Lucas to be indifferent between the two investments from a cash-flow perspective.

Question 14

Assume that Larry's marginal tax rate is 24 percent. If corporate bonds pay 7.2 percent interest, what interest rate would a municipal bond have to offer for Larry to be indifferent between the two bonds?

Accepted Answer

To be indifferent, the after-tax yield of the corporate bond should equal the yield of the municipal bond. The after-tax yield of the corporate bond is 7.2% * (1 - 0.24) = 5.472%. Therefore, the municipal bond should offer approximately 5.47%.

Question 15

Assume that Marsha is indifferent between investing in a city of Destin bond that pays 4.05 percent interest and a corporate bond that pays 6.05 percent interest. What is Marsha's marginal tax rate? (Do not round intermediate computations.)

Accepted Answer

The answer of Assume that Marsha is indifferent between investing...

Question 16

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?

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).

Question 17

Assume that Jose is indifferent between investing in a corporate bond that pays 10 percent interest and a stock with no growth potential that pays an 8.6 percent dividend yield. Assume that the tax rate on dividends is 15 percent. What is Jose's marginal tax rate? (Do not round intermediate computations.)

Accepted Answer

Jose is indifferent between investing in a corporate bond that pays 10 percent interest and a stock with no growth potential that pays an 8.6 percent dividend yield. Therefore, the after-tax return on the stock must be equal to or greater than the return on the bond. 
The after-tax return on the stock is (1 - 0.15) * 0.086 = 0.0731 or 7.31%. 
Since Jose is indifferent between the two, the marginal tax rate must be equal to the difference between the before-tax return on the bond (10%) and the after-tax return on the stock (7.31%), divided by the before-tax return on the bond (10%). 
Marginal tax rate = (10% - 7.31%) / 10% = 0.269 or 26.9%. Therefore, the answer is C.

Question 18

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?

Accepted Answer

The answer of Assume that Will's marginal tax rate is...

Question 19

Assume that Jose is indifferent between investing in a corporate bond that pays 10 percent interest and a stock with no growth potential that pays an 8 percent dividend yield. Assume that the tax rate on dividends is 15 percent. What is Jose's marginal tax rate?

Accepted Answer

If Jose is indifferent between the two investments, then his after-tax return on both must be equal. Let's first calculate the after-tax return on the stock:

Dividend yield = 8%
Tax rate on dividends = 15%
After-tax dividend yield = 8% * (1 - 0.15) = 6.8%

Now let's calculate the after-tax return on the corporate bond:

Interest rate = 10%
Since interest income is generally taxed at your marginal tax rate, we can use the following equation to calculate Jose's marginal tax rate:

after-tax bond yield = interest rate * (1 - marginal tax rate)
0.9 * 10% = 6.8%
marginal tax rate = 32%

Therefore, Jose's marginal tax rate is 32%.

Question 20

Assume that Lucas's marginal tax rate is 22 percent and his tax rate on dividends is 11 percent. If a dividend-paying stock (with no growth potential)pays an 9 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?

Accepted Answer

For Lucas to be indifferent between the two investments, the after-tax yield on the municipal bond needs to be the same as the after-tax yield on the dividend-paying stock.

First, we need to calculate the after-tax yield on the dividend-paying stock:
Dividend yield = 9%
Tax rate on dividends = 11%
After-tax dividend yield = Dividend yield * (1 - Tax rate on dividends) = 9% * (1 - 0.11) = 8.01%

Next, we need to find the interest rate on the municipal bond that would give us the same after-tax yield as the dividend-paying stock. We can use the formula:

After-tax yield on municipal bond = Interest rate on municipal bond * (1 - Marginal tax rate)

Solving for the interest rate on the municipal bond:

Interest rate on municipal bond = After-tax yield on dividend-paying stock / (1 - Marginal tax rate)
= 8.01% / (1 - 0.22)
= 10.29%

Therefore, the municipal bond would need to offer an interest rate of 10.29% for Lucas to be indifferent between the two investments. Since D is the closest option, it is the best choice.

Quiz 3: Tax Planning Strategies and Related Limitations