Question

Fergie has the choice between investing in a State of New York bond at 9.4 percent and a Surething Inc. bond at 12.0 percent. Assuming that both bonds have the same nontax characteristics and that Fergie has a 30 percent marginal tax rate, in which bond should she invest?

Answer 1

Answer:

She should invest in a State of New York bond.

Explanation:

The return on a State of New York bond is 9.4%.

The return on a Surething Inc. bond is 12%.

Fergie has a 30% marginal tax.

A state tax will not be taxed. However, a corporate bond will be taxed.

After tax return will be

= $12\% -\ (12\% \times\ 30\%)$

= $0.12\ -\ (0.12\ \times\ 0.3)$

= 0.12 - 0.036

= 0.084

So, the return after tax will be 8.4%.

This is lower than the return on the state bond.

So, Fergie will invest in State bond.