41 Hugh has the choice between Assuming that both bonds have

41 Hugh has the choice between Assuming that both bonds have the same nontax characteristics does Surething Inc, need to offer to make Hugh indifferent between investing in the two bonds? (Round places.) investing in a City of Heflin bond at 5.85 percent investing in a Surething bond at 8,75 percent n and that Hugh has a 40 percent marginal tax rate, what interest rate 0.5 References

Solution

Interest rate = 9.75%

Explanation:

To be indifferent between investing in the two bonds, the Surething, Inc. bond should provide Hugh the same after-tax rate of return as the City of Heflin bond (5.85 percent).

To solve for the required pretax rate of return we can use the following formula: After-tax return = Pretax return × (1 Marginal Tax Rate).

Surething, Inc. needs to offer a 9.75 percent interest rate to generate a 5.85 percent after-tax return and make Hugh indifferent between investing in the two bonds - i.e.,

5.85% = Pretax return × (1 40%);

Pretax return = 5.85% / (1 40%) = 9.75%