An investment is available that pays a tax-free 7%. The corporate tax rate is 40%. Ignoring risk,what is the pre-tax return on taxable bonds?
A) 4.20%
B) 7.00%
C) 7.47%
D) 11.67%
E) None of these.

Question

Quizplus · Accepted Answer

To find the pre-tax return on taxable bonds, we need to use the after-tax return on the tax-free investment. The after-tax return can be calculated as 7% * (1 - 40%) = 4.2%. To get the pre-tax return on taxable bonds, we need to solve for x in the equation 4.2% = x * (1 - corporate tax rate). Thus, x = 7% / (1 - 40%) = 11.67%. Therefore, the pre-tax return on taxable bonds is 11.67%. The best choice is D.

An Investment Is Available That Pays a Tax-Free 7