The following investments are available to you: (a) a taxable bond with a coupon
ID: 2421654 • Letter: T
Question
The following investments are available to you: (a) a taxable bond with a coupon rate of 5% per year; (b) a tax-exempt bond with a coupon rate of 3% per year; and (c) preferred stock that pays a 5% annual dividend. All three investments are currently selling at their face (par) values, so their pre-tax yields are equal their stated coupon (dividend) rates. Furthermore, asset values will not change over time.
You can hold each of these assets in any of three savings vehicles: (a) held directly; (b) a non-deductible IRA; or (c) a Roth IRA. Recall that all distributions in excess of your investment in a non-deductible IRA are taxed at ordinary income rates, and all distributions from a Roth IRA are tax-exempt.
Assuming a 10-year holding period, compute the after-tax annualized rate of return (r) for each combination of investment and savings vehicle shown in the following table. Assume that dividends earned in a taxable account are taxed at 15%, and ordinary income is taxed at 35%. Also, for sake of simplicity, assume that all earnings are reinvested in the same asset.
Table:
Taxable Bond Held Directly:
Taxable Bond Non-Deductible IRA:
Taxable Bond Roth IRA:
Tax-Exempt Bond Held Directly:
Tax-Exempt Bond Non-Deductible IRA:
Tax-Exempt Bond Roth IRA:
Preferred Stock Held Directly:
Preferred Stock Non-Deductible IRA:
Preferred Stock Roth IRA:
Explanation / Answer
The earnings on taxable bond,tax free bond and preferred stock is as follows:
The face value for all investment is taken as 100,000
a Taxable bonds with coupan rate 5% per year Amount Assume the bond face value 100000 Interest on bonds 5000 Interest for 10 years PV Annuity factor 38858 5000*7.771 Redemption value 100000 Interest income 38858 Tax @35% 13600 Total cash flows 125258 b Tax exempt with coupan rate of 3% per year Assume the bond face value 100000 Interest on bonds 3000 Interest for 10 years PV Annuity factor 29126 Total cash flows 129126 Preferredstock with 5% per year dividend Amount c Preferred stock face value 100000 Annual dividend 5000 Dividend for 10 years 50000 Cash flows 150000 Redemption value 100000 Annual dividend 50000 Tax @15% 7500 Total cash flows 142500Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.