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!
AT=BT X (1-T)
$42
To determine the rate that must be set on the Beverly bonds to make Jane interested in making a switch, we need to consider the after-tax yield on both the tax-exempt bonds and the taxable bonds.
1. Calculate the after-tax yield on the tax-exempt bonds:
The tax-exempt bonds pay 7 percent interest, which means Jane receives the full interest amount without any taxes deducted.
After-tax yield on tax-exempt bonds = 7%
2. Calculate the after-tax yield on the taxable bonds:
Jane is in the 49 percent tax bracket, which means she will have to pay taxes on the interest earned from the taxable bonds.
Let x be the rate set on the Beverly bonds that would make Jane interested in switching. Jane's after-tax yield on the taxable bonds would be (1 - 0.49) * x = 0.51x (after deducting 49% for taxes).
3. Equate the after-tax yields and solve for x:
0.51x = 7%
x = 7% / 0.51
x ≈ 13.73%
Therefore, the rate that must be set on the Beverly bonds to make Jane interested in making a switch is approximately 13.73%.