Question

Theresa Davis is in the 40 percent personal tax bracket. She is considering investing in HSA (taxable) bonds that carry a 12 percent interest rate.



What is her after-tax yield (interest rate) on the bonds?


Suppose Twin Cities Memorial Hospital has issued tax-exempt bonds that have an interest rate of 6 percent. With all else the same, should Kim buy the HCA or the Twin Cities bonds?


With all else the same, what interest rate on the tax-exempt Twin Cities bonds would make Kim indifferent between these bonds and the HCA bonds?

Answer 1

Based on the information given, it should be noted that the after tax yield on the bonds will be 7.2%

How to calculate the after tax yield.

It should be noted that the after tax yield will be:

= Interest × (1 - tax rate)

= 12 × (1 - 40%)

= 12 × (1 - 0.4)

= 12 × 0.6

= 7.2%

Also, Kim should buy the HCA bonds because their after tax yield is more than that of Twin cities.

Lastly, to make Kim indifferent between these bonds and the HCA bonds, Twin cities bonds should give an interest rate that's equal to 7.2%.

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