Assume that Lucas' marginal tax rate is 30% and his tax rate on dividends is 15%.If a dividend-paying stock (with no growth potential)pays an 8% 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?

Question

Quizplus · Accepted Answer

First, we need to calculate the after-tax return on the dividend-paying stock. 
After-tax dividend yield = Dividend yield x (1 - tax rate on dividends) 
After-tax dividend yield = 0.08 x (1 - 0.15) = 0.068 = 6.8%

Next, we need to find the pre-tax yield on a municipal bond that would give the same after-tax return. 
Municipal bond yield = After-tax return / (1 - marginal tax rate) 
Municipal bond yield = 0.068 / (1 - 0.3) = 0.097 = 9.7%

Therefore, if the municipal bond yield is 9.7%, Lucas would be indifferent between the two investments from a cash-flow perspective.

Assume That Lucas' Marginal Tax Rate Is 30% and His