Question

Assume that John's marginal tax rate is 40%. If a city of Austin bond pays 6% interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds?
A. 30%
B. 10%
C. 6%
D. 3.6%
E. None of these

Answer 1

Answer:

B. 10%

Explanation:

Given that

Tax rate = 40%

Net tax rate = 6%

Recall that

Gross interest = Net of tax rate / ( 1 - tax rate)

Therefore,

= 0.06 ÷ ( 1 - 0.40)

= 0.06 ÷ 0.60

= 0.1

= 10%