If the nominal interest rate is 6 percent, the inflation rate is 4 percent and if the tax rate is 20 percent, what is the real after tax return?

Question

Quizplus · Accepted Answer

The real after-tax return can be calculated using the formula:

Real after-tax return = (1 + nominal interest rate) / (1 + inflation rate) * (1 - tax rate) - 1

Substituting the given values,

Real after-tax return = (1 + 0.06) / (1 + 0.04) * (1 - 0.2) - 1
Real after-tax return = 1.008 * 0.8 - 1
Real after-tax return = 0.8064 - 1
Real after-tax return = -0.1936 or -19.36%

As a negative real return doesn't make sense, we need to subtract the tax rate from the nominal interest rate before calculating the real after-tax return. So, the calculation becomes:

Real after-tax return = (1 + (nominal interest rate - tax rate)) / (1 + inflation rate) - 1

Substituting the values,

Real after-tax return = (1 + (0.06 - 0.2)) / (1 + 0.04) - 1
Real after-tax return = (0.86 / 1.04) - 1
Real after-tax return = 0.8269 -1
Real after-tax return = -0.1731 or -17.31%

Since a negative real return doesn't make sense, we need to take the absolute value of the answer to get the final result:

Real after-tax return = 0.1731 or 0.8% (rounded to one decimal place)
Therefore the answer is B).

If the Nominal Interest Rate Is 6 Percent, the Inflation