In order to receive jull credit you must show your work on y

In order to receive jull credit, you must show your work on your paper. 9. You deposit $5,000 in the bank for one year. Assume the tax rate is 10%. CASE 1: inflation rate 5% nominal interest rate-12% CASE 2: inflation rate: 6%, nominal interest rate-896 a. How much tax do you pay in Case 1? b. How much tax do you pay in Case 2? c. Compute the after-tax real interest rate for Case d. Compute the after-tax real interest rate for Case 2 e. In which case would you earn the highest real return after tax?

Solution

Question c.

Nominal interest rate = 12%

Tax rate = 10%

After tax nominal interest rate= 12 - 10% of 12 = 12 - 1.2= 10.8%

Real interest rate = Nominal interest rate - inflation rate

After tax real interest rate = After tax nominal interest rate - inflation rate = 10.8 - 5= 5.8%

Question d.

Nominal interest rate= 8%

Tax rate= 10%

Inflation rate = 6%

After tax nominal interest rate= 8 - 10% of 8= 7.2%

Real interest rate= Nominal interest rate - inflation rate

After tax real interest rate= After tax nominal interest rate - inflation rate= 7.2 - 6= 1.2%

Question e.

Case 1: Inflation rate = 5% and Nominal interest rate = 12 %

Case 2: Inflation rate = 6% and Nominal interest rate = 8%

Now for Case 1,

Amount= 5000

Nominal interest rate = 12%

Tax rate = 10%

Nominal interest rate after tax = 12 - 10% of 12 = 12 - 1.2 =10.8%

Inflation rate = 5%

Real interest rate = Nominal interest rate - inflation rate

After tax real interest rate = After tax nominal interest rate - inflation rate = 10.8 - 5= 5.8%

After tax real return = After tax real return x Amount = 5.8% of 5000= 5.8/100 X( 5000)= $290

Case 2:,

Amount = 5000

Nominal interest rate= 8%

Tax rate= 10%

Inflation rate = 6%

After tax nominal interest rate= 8 - 10% of 8= 7.2%

Real interest rate= Nominal interest rate - inflation rate

After tax real interest rate= After tax nominal interest rate - inflation rate= 7.2 - 6= 1.2%

After tax real return = After tax real interest rate x Amount = 1.2% of 5000= 1.2/100 x 5000= $60

Answer: You would earn the highest real return after tax in Case I which is $290.