Jane Smith currently holds tax-exempt bonds of Good Samaritan Healthcare that pay 7 percent interest. She is in the 49 percent tax bracket. Her broker wants her to buy some Beverly Enterprises taxable bonds that will be issued next week. With all else the same, what rate must be set on the Beverly bonds to make Jane interested in making a switch!

Harry Balls

47

To determine the rate that must be set on the Beverly bonds to make Jane interested in making a switch, we need to compare the after-tax yield of the tax-exempt bonds she currently holds with the yield of the taxable Beverly bonds.

First, we calculate the after-tax yield of the tax-exempt bonds:

After-tax yield = Tax-exempt yield * (1 - Tax rate)
= 7% * (1 - 0.49)
= 7% * 0.51
= 3.57%

Now, we need to find the rate on the Beverly bonds that would make Jane interested in switching. We can set up an equation:

Beverly bonds yield * (1 - Tax rate) = Tax-exempt yield

Let's substitute the values we have:

Beverly bonds yield * 0.51 = 3.57%

To solve for the Beverly bonds yield, we divide both sides of the equation by 0.51:

Beverly bonds yield = 3.57% / 0.51
≈ 7%

Therefore, the rate that must be set on the Beverly bonds to make Jane interested in making a switch is approximately 7%.