Carter Corporation has some money to invest,and its treasurer is choosing between City of Chicago municipal bonds and U.S.Treasury bonds.Both have the same maturity,and they are equally risky and liquid.If Treasury bonds yield 6.00%,and Carter's marginal income tax rate is 25.00%,what yield on the Chicago municipal bonds would make Carter's treasurer indifferent between the two?

Question

Quizplus · Accepted Answer

To make the treasurer indifferent between the two bonds, the after-tax yield of the Treasury bonds must equal the yield of the municipal bonds. The after-tax yield of the Treasury bonds is calculated as the yield times (1 - tax rate). So, for Treasury bonds yielding 6.00% and a tax rate of 25%, the after-tax yield is 6.00% * (1 - 0.25) = 6.00% * 0.75 = 4.50%. Therefore, a yield of 4.50% on the Chicago municipal bonds would make the treasurer indifferent between the two, as municipal bond interest is generally exempt from federal income taxes.

Carter Corporation Has Some Money to Invest,and Its Treasurer Is