Question

Hugh has the choice between investing in a city of heflin bond at 6 percent or investing in a surething inc. Bond at 9 percent. Assuming that both bonds have the same nontax characteristics and that hugh has a 40 percent marginal tax rate, in which bond should he invest?.

Answer 1

Based on the Heflin City Bond return and the corporate bond return, Hugh should invest in the Heflin City Bond.

The decision to invest in a bond in this instance, should be driven by which bond has the better after tax return.

Surething Inc After tax return.

=  Return x ( 1 - tax rate)

= 9% x ( 1 - 40%)

= 5.4%

Heflin bonds are not taxed as they are municipal bonds. The bond with a higher after tax return is therefore the Heflin bond at 6%.

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