Question

45. Steven has $100,000 to purchase a bond. Two bonds of similar credit risk are available. The first is taxable with an eight-percent yield; the second is tax-exempt with a five-percent yield. Steven is in the 39.6 percent federal income tax bracket and the 3.23 percent state income tax bracket. Which bond should Steven purchase? How much higher is his return in the first year for this bond versus the other? taxable : 100,000 * 8%= 8,000 income, * (39.6% +3.23% tax rate), = $3,426.40 taxes due, $4,573.60 net earnings Tax exempt: $100,000 * 5% earnings = $5,000 income, $5,000 net earnings

Answer 1

Taxable bond Before tax return = Yield * amount invested

= 8%*100000

= 8000

Taxable bond after tax return = Pre tax return—Taxes

= 8000- 39.6%*8000- 3.23%*8000

=8000-3168-258.4

= 4573.60

Tax exempt bond yield = 5%*100000 = 5000

Purchase the tax exempt bond. Amount by which the earnings are higher = 5000-4573.60 = 426.40