Suppose you are an investor with a choice between three investments in debt securities that are identical in every way except in terms of their interest rates and taxability.
Investment A:Interest rate 10 percent, tax rate 40 percent of interest incomeInvestment B:Interest rate 8 percent, tax rate 30 percent of interest incomeInvestment C:Interest rate 6.5 percent, tax rate 0 percentWhich investment provides the highest after-tax return? Show your work.
What will be an ideal response?
After-tax return = (1 ?t) × interest rate.
| A: | (1 ? 0.40) × 10% = 6.0% |
| B: | (1 ? 0.30) × 8% = 5.6% |
| C: | (1 ? 0) × 6.5% = 6.5% |
Business
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