Please show the calculation sure so i can understand how i get the answer Reggie
ID: 2769724 • Letter: P
Question
Please show the calculation sure so i can understand how i get the answer
Reggie White, a corporate treasure, is trying to decide which of two 1-year securities to purchase: a negotiable CD with a nominal yield of 6 percent or a municipal security with a nominal yield of 4.25 percent. the issuing municipality is not in the same stale as Reggie's company, but he recognizes that the muni's interest is exempt from federal income taxation. His company s marginal federal tax rate is 39 percent. Which security should the treasurer select, assuming the securities have equal default risk?Explanation / Answer
To decide which type of investment i.e investment in negotiable CD which gives 6% yield which is taxable like an ordianry income or in Municipal bonds which yield 4.25% and tax free. To decide whcih is the best investment,we should calculate Taxable equvalent yield on muncipal bond by applying the following formula ie.
Taxable equivalent yield = Tax free yield / 1 - tax bracket = 4.25/1-.39 = 4.25/0.61 = 6.97%
Hence, net return on muncipal bond is 6.97% per annum, but on negotial CD it is only 6% (as it is taxable), The net return on Muncipal bond is more than on negotiable CD, so for Riggie White it is better to invest on Muncipal bonds as it yields more than netotiable CD