A corporate bond is providing a yield of 12% per year, while at the same time; a municipal bond (tax exempt) is yielding 9% per year.
Each bond only pays interest each year until the bond matures, at which time the principal investment will be returned. Each bond is equally risky, and your marginal tax bracket is 30% you have $1,000 to invest.
A) What is the after tax cash flow from each bond? Which bond would you invest?
B) What is the percentage after tax return on each bond?
C) What before tax equivalent on the corporate bond would make you choose it as an investment?
D) Suppose that you are also subject to a 5% state tax from which neither the corporate or municipal bond is tax exempt. What is the after tax return on each bond?