4814 Words20 Pages

Chapter 11
Investments
SOLUTIONS MANUAL
49. [LO 1] Dana intends to invest $30,000 in either a Treasury bond or a corporate bond. The Treasury bond yields 5 percent before tax and the corporate bond yields 6 percent before tax. Assuming Dana’s federal marginal rate is 25 percent and her marginal state rate is 5 percent which of the two options should she choose? If she were to move to another state where her marginal state rate would be 10 percent, would her choice be any different? Assume that Dana itemizes deductions.
When the state rate is 5 percent, Dana would achieve the following returns from the Treasury bond or the corporate bond:
The Treasury bond yields $1,125 or $30,000 x [.05 x (1-.25)] after tax. The corporate bond yields $1,282.50 or $30,000 x [.06 x (1 - .25 - .05(1-.25))] after tax. Note that the actual state rate is reduced by 25% to allow for the deductibility of state income taxes on the federal income tax return. Thus, she should choose the corporate bond.
When the state rate is 10%, Dana would achieve the following returns from the Treasury bond or the corporate bond:
The Treasury bond would still yield $1,125 or $30,000 x [.05 x (1-.25)] after tax because state rates don’t affect after- tax returns from Treasury bonds. The corporate bond yields $1,215 or $30,000 x [.06 x (1 - .25 - .10(1-.25))] after tax. Again, note that the actual state rate is reduced by 25% to allow for the deductibility of state income taxes on the federal income tax return. If Dana’s state tax rate increases to 10%, corporate bonds are still superior to Treasury bonds.
50. [LO 1] At the beginning of his current tax year David invests $12,000 in original issue U.S. Treasury bonds with a $10,000 face value that mature in exactly 10 years. David receives $700 in interest ($350 every six months) from the Treasury bonds during the current

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