Curtis invests $400,000 in a city of Athens bond that pays 6 percent interest. Alternatively, Curtis could have invested the $400,000 in a bond recently issued by Initech, Incorporated that pays 6.75 percent interest with similar risk as the city of Athens bond. Assume that Curtis's marginal tax rate is 24 percent. What is Curtis's after-tax rate of return on the city of Athens bond?

Question

Quizplus · Accepted Answer

First, we need to calculate the interest income from the city of Athens bond:
Interest income = $400,000 x 0.06 = $24,000

Next, we need to calculate the tax liability on the interest income:
Tax liability = $24,000 x 0.24 = $5,760

After deducting the tax liability from the interest income, we get the after-tax interest income:
After-tax interest income = $24,000 - $5,760 = $18,240

The after-tax rate of return on the city of Athens bond can be calculated as follows:
After-tax rate of return = (After-tax interest income / Initial investment) x 100%
After-tax rate of return = ($18,240 / $400,000) x 100%
After-tax rate of return = 0.0456 x 100%
After-tax rate of return = 4.56%

Therefore, Curtis's after-tax rate of return on the city of Athens bond is 4.56%. Since the bond recently issued by Initech, Incorporated pays a higher rate of interest with similar risk, it would be a better investment choice for Curtis.

Curtis Invests $400,000 in a City of Athens Bond That