Question

Assume that Lucas's marginal tax rate is 32 percent and his tax rate on dividends is 15 percent. If a dividend-paying stock (with no growth potential) pays an 8 percent dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments from a cash-flow perspective?

Answer 1

Answer:

6.8%

Explanation:

Data provided in the question:

Marginal tax rate = 32%

Tax rate on dividends = 15%

Dividend yield = 8%

Now,

Interest rate municipal bond will offer

= Dividend yield × ( 1 - Tax rate on dividend )

or

Interest rate = 8% × ( 1 - 15% )

or

Interest rate = 8% × ( 1 - 0.15 )

Interest rate = 8% × 0.85

Interest rate = 6.8%