Question

ssume that John Richards pays income taxes at a 30 percent rate. He currently owns a not-for-profit (municipal) bond that pays 5 percent interest. What interest rate would have to be set on a for-profit (corporate) bond to produce the same amount of usable (after-tax) income

Answer 1

Answer:

7.14%

Explanation:

Tax rate applicable for John Richards =30%. So, Post Tax profit for corporate bond will be 70% (1 - 30%) of profit.

Required post tax profit from Corporate Bond is 5%.

Required pretax profit from Corporate bond = 5%/70% = 0.071429 = 7.14%

Therefore, to get 5% post tax profit from corporate bond, the interest rate needs to be set on 7.14% to produce the same amount of usable (after-tax) income.