A 5-year corporate bond yields 8.00%.A 5-year municipal bond of equal risk yields 6.50%.Assume that the state tax rate is zero.At what federal tax rate are you indifferent between the two bonds? (Round your final answer to two decimal places. )

Question

Quizplus · Accepted Answer

To be indifferent between the two bonds, the after-tax yield of the corporate bond must equal the yield of the municipal bond. The formula to calculate the equivalent tax rate is: Tax Rate = (Municipal Bond Yield) / (Corporate Bond Yield). Plugging in the given yields: Tax Rate = 6.50% / 8.00% = 0.8125 or 81.25%. However, this calculation is incorrect based on the initial question's context. The correct approach is to find the tax rate at which the after-tax return of the corporate bond equals the municipal bond yield. The correct formula considering tax impact on the corporate bond yield is: Municipal Bond Yield = Corporate Bond Yield * (1 - Tax Rate). Rearranging for Tax Rate gives us: Tax Rate = 1 - (Municipal Bond Yield / Corporate Bond Yield) = 1 - (6.50 / 8.00) = 1 - 0.8125 = 0.1875 or 18.75%.

A 5-Year Corporate Bond Yields 8