Answer:
a. After-tax return for corporate bond $1,700.
b. After-tax return for municipal bond = $1,500.
c. After-tax return for Stock = $1,320
d. Which investment should Elizabeth choose?Corporate Bonds .
Explanation:
The question is to calculate a few figures and the steps are detailed below
1)The After tax Return for the Corporate Bond
Interest and dividend is received at the end of 6 months period
Therefore: The interest = 6/12 x 100,000 x 5%) = $2,500
Secondly subtract tax from the interest= 32% of $2,500 = 800
therefore, Interest after tax = $2,500-$800 = $1.700
2)Calculate the After tax return on Municipal bonds
First, the interest on the municipal bonds =
6/12 x $100,000 x 3% = $1,500
Since municipal bonds interests are tax exempt. The amount remains
3) Determine the after tax return on stock
First, the dividend = $1,000 subtract tax (0.32 x 1,000)
= $1,000-$320 = $680
Secondly, since the capital appreciation on the stock is to be computed as follows:
6/12 x $100,000 x 2% = $1,000
subtract tax (0.32 x 1,000)
= $1,000-$320 = $680 (this is the net appreciation)
This means that net tax return on stock is 680 + 680 = $1,320
This is based on the assumption of stock sales at the end of the 6th month leading to the use of a marginal tax rate.
D) Elizabeth would be advised to invest in the asset with the highest after tax return which is the corporate bond
