Question

Jack has $1,000 to invest. He has a choice between municipal bonds with an interest rate of 4% or corporate bonds with an interest rate of 6%. Jack has a marginal tax rate of 25%. Given this information, Jack should invest in the bonds. The after-tax rate of return on the municipal bonds is % and the after tax rate of return on the corporate bonds is %. The difference in the rates of return is known as taxes.

Answer 1

Answer:

Ans. The after-tax rate of return on the municipal bonds is 3% and the after tax rate of return on the corporate bonds is 4.5%

Explanation:

Hi, the formula to find the after-tax rate of return of any taxable income is as follows.

$r(AfterTax)=r(BeforeTax)*(1-Taxes)$

Therefore, in the case of the municipal bond.

$r(AfterTax)=0.04*(1-0.25)=0.03$

So, the after-tax rate of return of the municipal bond is 3%.

And for the corporate bond is.

$r(AfterTax)=0.06*(1-0.25)=0.045$

And the after-tax rate of return of the corporate bond is 4.5%.

It means that taxes on municipal bonds are:

$Taxes= Return(BeforeTax)-Return(AfterTax)$

In the case of municipal taxes:

$Taxes=0.04-0.03=0.01$

1% taxes for municipal bonds

In the case of corporate taxes:

$Taxes=0.06-0.045=0.015$

1.5% taxes for corporate bonds

Best of luck.