Answered

Hugh has the choice between investing in a City of Heflin bond at 4.95 percent or investing in a Surething Inc. bond at 7.60 percent. Assuming that both bonds have the same nontax characteristics and that Hugh has a 40 percent marginal tax rate, what interest rate does Surething Inc. need to offer to make Hugh indifferent between investing in the two bonds? (Round your answer to 2 decimal places.)

Answer :

Tundexi

Answer:

8.25%

Explanation:

Hugh will pay tax on its interest income and hence teh after tax rate of income shall be = Interest rate * (1- tax) . City of Heflin bond is offering a rate of 4.95% after tax rate of return, hence Surething should offer a interest rate that given Hugh after tax rate of 4.95%.

Tax rate is given 40% = 0.40

So , Interest rate * (1 - tax) = 4.95%

Interest rate * (1 - 0.40) = 0.0495

Interest rate * 0.60 = 0.0495

Interest rate = 0.0495 / 0.60

Interest rate = 0.0825

Interest rate = 8.25%

Hence Surething should offer 8.25% interest rate.

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