Bill Smith, a manager of a restaurant/bar in Los Angeles, is in the 25% marginal tax bracket and pays an additional 5% in taxes to the state of California. Bill has $20,000 invested in corporate bonds which is currently earning an average annual return of 7.5%.
Additionally, Bill also has another $20,000 invested in municipal bonds from the city of Los Angeles that are being used to redevelop depressed areas downtown. These bonds pay an average return of 5.4%.
Assume that in both cases, Bill earns the same returns as calculated on both the corporate and municipal bonds each year for the next 15 years.
Answer the following:
- What is the after-tax return on Bill's corporate bonds for the current year?
- What is the after-tax return on his municipal bonds for the current year?
- Which investment earns more returns: corporate or municipal bonds?
- What would the balance in each account be at the end of the fifteenth year?