John Friedman is in the 40 percent personal tax bracket. He is considering inves

Question

John Friedman is in the 40 percent personal tax bracket. He is considering investing in HCA bonds that carry a 12 percent interest rate.

            (a). What is his after-tax yield (interest rate) on the bonds?

            (b). Suppose Twin Cities Memorial Hospital has issued tax-exempt bonds that have an interest rate of 6 percent. With all else the same, should john buy the HCA or he Twin Cities bonds?

            (c). With all else the same, what interest rate on the tax-exempt Twin Cities bonds would make john indifferent between these bonds and the HCA bonds?

Explanation / Answer

HCA bonds Interest Rate 12% Tax Bracket 40% After tax yield 7.20% =(1-40%)*12% Twin Cities bond Interest rate 6% Tax 0% After tax yield 6.00% =(1-0%)*6% a 7.20% b So, He should buy HCA bonds as their yield is higher even after the taxes c With an interest rate of 7.2% on Twin Cities memorial bond john should be indifferent* Note: an important point to be noted is that even with the same yield if the two bonds would have been from different sectors john might not have been indifferent. In this case since both the bonds are issued by players in the same sector of economy, john is indifferent.

Related Questions

Navigate

• Browse (All)
• Browse J
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.