Question

Corporate bonds issued by Johnson Corporation currently yield 12%. Municipal bonds of equal risk currently yield 6.5%. At what tax rate would an investor be indifferent between these two bonds? Round your answer to two decimal places.

Answer 1

Answer:

the tax rate should be of 45.83% to make indifferent for the investor

Explanation:

the municipal bonds pay no income tax according to United States IRS regulation

Therefore their rate will be the equivalent of the after-tax rate of a corporate bonds

to make it indifferent we should look at the rate that makes the after tax yield of the 12% equal to 6.5%

$pretax \times (1 + t ) = after-tax$

0.12 x (1-t) = 0.065

1 - 0.065/0.12 = t

t = 0.4583 = 45.83%

the tax rate should be of 45.83 to make indifferent for the investor