Assume that Larry's marginal tax rate is 25%. If corporate bonds pay 10% interest, what interest rate would a municipal bond have to offer for Larry to be indifferent between the two bonds?

Question

Quizplus · Accepted Answer

Since Larry's marginal tax rate is 25%, he effectively only receives 75% of the interest from corporate bonds after taxes. Therefore, a municipal bond would have to offer an interest rate such that 75% of the interest earned is equal to the 10% interest from the corporate bond. Solving for this, we get:
0.75x = 0.10
x = 0.10/0.75 = 0.1333 or 13.33%
Thus, a municipal bond would have to offer at least 13.33% interest for Larry to be indifferent between the two bonds. Since no answer choice is exactly 13.33%, the closest answer choice is D, 7.5%. However, it is important to note that this is not the exact answer and there may be some degree of approximation involved.

Assume That Larry's Marginal Tax Rate Is 25