What explicit tax rate would keep Jason indifferent between purchasing a municipal bond with a 3.0 percent return and a taxable bond with a 4.5 percent before-tax return? (Round your answer to the nearest percent)

Question

Quizplus · Accepted Answer

To calculate the tax-equivalent yield, we need to find the tax rate at which Jason would be indifferent between the two bonds.

Taxable Bond Yield after-tax = 4.5% * (1 - tax rate)

Municipal Bond Yield = 3.0%

Setting these two equal to each other and solving for the tax rate gives:

4.5% * (1 - tax rate) = 3.0%

(1 - tax rate) = 3.0%/4.5% = 2/3

tax rate = 1 - 2/3 = 1/3 or 33%

Therefore, the explicit tax rate that would keep Jason indifferent between the two bonds is 33%. This means that if Jason's marginal tax rate is less than 33%, he should choose the taxable bond, and if it is greater than 33%, he should choose the municipal bond.

Answer: C) is the best choice.

What Explicit Tax Rate Would Keep Jason Indifferent Between Purchasing