A) Say you buy a -exa-Tax Free bond that offers 5.75% annual return. If your mar

Question

A) Say you buy a -exa-Tax Free bond that offers 5.75% annual return. If your marginal Federal tax rate is 25% and Te*, state tax rate is 6.9%, find out the effective tax equivalent return. A. Federal tax rate B. T Xstate tax rate C. Add A & B: Combined tax rate D. Subtract C from 100% E. Divide bond return by D: tax-equivalent return Check: Assume you have invested $10,000 in of the two bonds a) above tax-free bond with 5.75% return and another bond with taxable return as found in row E. Both should have equal after-tax return. Show it with calculations B) Say you buy a T Tax Free bond that offers 6.25% annual return. If your marginal state tax rate is 6.9%, find out the effective tax- Federal tax rate is 28% and equivalent return. Use the format in (A) to find tax-equivalent return. Also show E.

Explanation / Answer

Check,

Invested 10,000 in tax free bond with 5.75% return

Return = $10,000 * 5.75% = $57.5

tax equivalent return = 57.5 / 68.1% = $84.4

Invested 10,000 in bond with 8.44% return

Return = 10,000 * 8.44% = $84.4

B.

A. Federal tax rate 25.0% B. State tax rate 6.9% C. Add A & B: Combined tax rate 31.9% D. Subtract C. from 100% 68.1% E. Divide bond return by D : tax equivalent return 8.44%

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