You purchase a one-year security with an expected real pretax return of 6%. You forecast a 4% rate of inflation and are in the 35% tax bracket. Your real after-tax return would be
A) 6.1%.
B) 1.4%.
C) 2.6%.
D) 7.0%.

Question

Quizplus · Accepted Answer

The real after-tax return can be calculated using the formula: $$ \text{Real After-Tax Return} = \frac{\text{Nominal Return} - \text{Taxes Paid}}{1 + \text{Inflation Rate}} - 1 $$ Given a nominal return of 6% and an inflation rate of 4%, the taxes paid on the nominal return for someone in the 35% tax bracket would be $6\% \times 35\% = 2.1\%$. Thus, the after-tax nominal return is $6\% - 2.1\% = 3.9\%$. Adjusting this for inflation: $$ \text{Real After-Tax Return} = \frac{3.9\%}{1 + 4\%} - 1 = \frac{3.9\%}{1.04} - 1 \approx 2.6\% $$

You Purchase a One-Year Security with an Expected Real Pretax