Question

Hugh has the choice between investing in a City of Heflin bond at 3.30 percent or investing in a Surething bond at 5.15 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? (Round your answer to 2 decimal places.)

Answer 1

Answer:

Hugh has a 40 percent marginal tax rate.

Investment in City of Heflin bond earns 3.30 percent

Interest on Surething bond is taxable and interest on City of Heflin bond is tax free.

Interest rate Surething Inc. need to offer to make Hugh indifferent between investing in the two bond

= 3.30% /( 1 - Marginal tax rate)

= 3.30% / (1 - 40%)

= 5.50%

Interest rate Surething Inc. need to offer to make Hugh indifferent between investing in the two bond = 5.50%