Question

Assume that you are in the 25% marginal tax bracket and that you have $50,000 to invest. You have narrowed your investment choices down to municipal bonds yielding 7% or equally risky corporate bonds with a yield of 10%. Which one should you choose and why

Answer 1

Answer: The corporate bond yield of 10% should be chosen

Explanation:

Based on the information given, we should note that the municipal bond will yield 7% and the corporate bind will yield an after tax of

= 10% × (1 - 25%)

= 10% × 75%

= 750%

= 7.50.

Therefore, we can see that the after tax yield of the corporate bond is higher and therefore should be chosen