A corporation has an average tax rate of 25% and a marginal tax rate of 39%. The

Question

A corporation has an average tax rate of 25% and a marginal tax rate of 39%. The corporation can invest in a tax-free project with an expected before-tax return of 6.8% or in a taxable project with an expected before-tax return of 10%. The corporation should:

A.) invest in the tax-free project because the after-tax return is greater.
B.) invest in the taxable project because the return is greater.
C.) be indifferent between the two investments because the after-tax returns are the same.

D.)invest in the taxable project because the after-tax return is greater.

Explanation / Answer

After tax return in case of :

Tax free project = 6.8% ( 1- 0 ) = 6.8%

Taxable project = 10 % (1 - .39 ) = 10* .61 = 6.1%

corrct option is "A" - Invest in tax free project because after tax return is greater.

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