Assume that Jose is indifferent between investing in a corporate bond that pays 10% interest and a stock with no growth potential that pays an 8% dividend yield.Assume that the tax rate on dividends is 15%.What is Jose's marginal tax rate?
A)47%.
B)37%.
C)32%.
D)15%.
E)None of the choices are correct.

Question

Quizplus · Accepted Answer

If Jose is indifferent between the corporate bond and the stock, then their after-tax yields must be the same.

For the bond, the after-tax yield is:

10% * (1 - 0) = 10%

For the stock, the after-tax yield is:

8% * (1 - 0.15) = 6.8%

So, Jose must be in a tax bracket where the marginal tax rate is 15%. To find the income level that corresponds to this tax bracket, we need to consult the tax brackets for the relevant year. Assuming the current (2021) tax brackets in the US, an individual with a taxable income between $40,525 and $86,375 is subject to a marginal tax rate of 22%, which is higher than the required 15%. However, an individual with a taxable income between $9,876 and $40,125 is subject to a marginal tax rate of 12%, which is consistent with the 15% after-tax yield on the stock. Therefore, Jose's marginal tax rate must be 12%.

Assume That Jose Is Indifferent Between Investing in a Corporate