Assume that the tax rates on corporate taxable income up to $50000 is 15% and 25
ID: 2815919 • Letter: A
Question
Assume that the tax rates on corporate taxable income up to $50000 is 15% and 25% for income levels between $50001 and $75000. If the Clumsy Chihuahua Music company has a taxiable income of $71000, then it has a tax liability of__________ and an average tax rate of__________.
suppose you want to invest $10000. You have two options:
option1: Invest in municipal bonds with an expected return of 13% or..
option2: Invest in the corporate bonds of jeffery inc. Which are offering an expected return of 18.85%
Assume that your decision is based solely on your tax situation . If everyonelse is same for both bonds, at what tax rate would you be indifferent between these two bonds investments?
A. 39.68% B. 31.00% C. 34.10% D. 28.83%
Explanation / Answer
Answer 1st Part:
Tax rates on corporate taxable income up to $50,000 is 15% and
Tax rate is 25% for income levels between $50,001 and $75,000.
Company has a taxable income = $71000
Hence,
Tax amount on corporate taxable income up to $50000 = $50,000 * 15% = $7,500
Tax amount for balance ($71,000 -$50,000=) $21,000 = $21,000 * 25% = $5,250
Hence Tax liability = $7,500 + $5,250 = $12,750
Average Tax rate = Tax Liability /Taxable Income = $12,750 /$71,000 = 17.96%
If the Clumsy Chihuahua Music Company has a taxable income of $71000, then it has a tax liability of $12,750 and an average tax rate of 17.96%
Answer 2nd Part:
Correct answer is:
B. 31.00%
Workings:
Option1: Invest in municipal bonds with an expected return of 13%
As interest on municipal bonds is tax free, post tax return is also = 13%
Option2: Invest in the corporate bonds of Jeffery Inc. and expected return = 18.85%
Interest earning on corporate bond is taxable.
Let us assume tax rate at which I would be indifferent between these two bonds investments = T%
I would be indifferent if post tax return is same.
Post Tax return of corporate bond = 18.85% * (1 - T %)
Hence,
18.85% * (1 - T %) = 13%
=> T = (18.85% - 13%) / 18.85% = 31.03%.
The closest option out of 4 options is B. 31.00%
Other options will not result in indifference point and hence are incorrect.