Question

Hugh has the choice between investing in a city of heflin bond at 6.45 percent or a surething bond at 10.40 percent. assuming that both bonds have the same nontax characteristics and that hugh has a 40 percent marginal tax rate. what interest rate does surething inc., need to offer to make hugh indifferent between investing in the two bonds?

Answer 1

Surething Inc. must give an interest rate of 17.33 percent to generate a 10.40 percent after-tax return and make Hugh indifferent between investing in the two bonds.

To solve for the pretax rate of return, we can use this formula:

 After-tax return = Pre-tax return x (1 – Marginal Tax Rate).

10.40% = Pre-tax return x (1 – Marginal Tax Rate);

Pre-tax return = 10.40% / (1 – Marginal Tax Rate) = 17.33%