ExpertEasy1 markMultiple Choice
CPA · Question 42 · Area I: Individual Compliance and Planning
A taxpayer is considering investing in a Municipal Bond yielding 3% or a Corporate Bond yielding 5%. The taxpayer's marginal tax rate is 35%. Which investment provides the higher after-tax return?
A taxpayer is considering investing in a Municipal Bond yielding 3% or a Corporate Bond yielding 5%. The taxpayer's marginal tax rate is 35%. Which investment provides the higher after-tax return?
Answer options:
A.
Municipal Bond (3.0%)
B.
Corporate Bond (3.25%)
C.
They are equivalent.
D.
Cannot be determined.
How to approach this question
Calculate Tax Equivalent Yield or After-Tax Yield. After-Tax Corp = 5% * (1 - 0.35) = 3.25%. Compare to Muni (3%).
Full Answer
B.Corporate Bond (3.25%)✓ Correct
B
After-tax return on Corporate Bond = 5% * (1 - 0.35) = 3.25%. This is higher than the 3% tax-free return on the Municipal Bond.
Common mistakes
Comparing pre-tax yields directly.
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