Question

Hugh has the choice between investing in a City of Heflin bond at 6 percent or investing in a Surething Inc. bond at 9 percent. Assuming that both bonds have the same nontax characteristics and that Hugh has a 40 percent marginal tax rate, what interest rate does Surething Inc. need to offer to make Hugh indifferent between investing in the two bonds

Answer 1

Answer: 10%

Explanation:

The City of Helfin bond is a municipal bond so it is tax exempt. The Surething bond is not however so the interest rate that would make Hugh indifferent is one that would equate the after tax return on the Surething bond to that of the City of Helfin.

6% = x ( 1 - Tax)

6% = x ( 1 - 0.4)

x = 6%/0.6

= 10%