Give reasons for your answer in 5(d) above: ....................................

Question

Give reasons for your answer in 5(d) above: ........................................................................................................... An investors who pay higher taxes may want to consider investing in tax-free municipal bonds or equivalent investments. The higher tax bracket an individual is in, the more appealing a tax-free investment would become. The equivalent yield formula below can be used to compare the yield on the tax-free investment versus an investment that is taxed. Suppose an investor purchased a tax-free city bond paying 5%. What is the equivalent yield on a taxable corporate bond at a marginal tax rate of 30%? Tax equivalence = Tax-free yield/(1 - marginal tax free)

Explanation / Answer

6 Tax Equivalence= Tax-free Yield/(1-Marginal Tax-rate)                                  =0.05/(1-0.30) 0.071429 Equivalent Yield= ie. 7.14%

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