Curtis invests $450,000 in a city of Athens bond that pays 6.50 percent interest. Alternatively, Curtis could have invested the $450,000 in a bond recently issued by Initech, Incorporated that pays 7.75 percent interest with similar risk as the city of Athens bond. Assume that Curtis's marginal tax rate is 24 percent. How much implicit tax would Curtis pay on the city of Athens bond?

Question

Quizplus · Accepted Answer

The implicit tax is the difference in interest Curtis forgoes due to the tax-exempt status of the city bond. The taxable equivalent yield of the city bond is 6.50% / (1 - 0.24) = 8.55%. The difference between the Initech bond yield (7.75%) and the taxable equivalent yield (8.55%) is 0.80%. The implicit tax is 0.80% of $450,000, which is $3,600. However, the correct calculation should consider the actual interest difference: (7.75% - 6.50%) * $450,000 = $5,625.

Curtis Invests $450,000 in a City of Athens Bond That