Question

Melinda invests $200,000 in a City of Heflin bond that pays 6 percent interest. Alternatively, Melinda could have invested the $200,000 in a bond recently issued by Surething Inc., that pays 8 percent interest and has risk and other nontax characteristics similar to the City of Heflin bond. Assume Melinda’s marginal tax rate is 25 percent. (Leave no cells blank - be sure to enter "0" wherever required.)
Required:

What is her after-tax rate of return for the City of Heflin bond?
How much explicit tax does Melinda pay on the City of Heflin bond?
How much implicit tax does she pay on the City of Heflin bond?
How much explicit tax would she have paid on the Surething Inc. bond?
What is her after-tax rate of return on the Surething Inc. bond?

Answer 1

Answer:

What is her after-tax rate of return for the City of Heflin bond?

• Melinda's after tax rate of return for the City of Heflin bonds = $200,000 x 6% = $12,000. Interest revenue from city bonds is not taxed.

How much explicit tax does Melinda pay on the City of Heflin bond?

• $0

How much implicit tax does she pay on the City of Heflin bond?

• $4,000. The tax difference between the yields of the city bond vs Surething bond.

How much explicit tax would she have paid on the Surething Inc. bond?

• ($200,000 x 8%) x 25% = $4,000

What is her after-tax rate of return on the Surething Inc. bond?

• ($16,000 - $4,000) / $200,000 = $12,000 / $200,000 = 6%