An investor in a 28% tax bracket is trying to decide whether to invest in a municipal bond or a corporate bond. She looks up municipal bond yields (rm) but wishes to calculate the taxable equivalent yield r. The formula she should use is given by ________.
A) r = rm × (1 - 28%)
B) r = rm / (1 - 72%)
C) r = rm × (1 - 72%)
D) r = rm / (1 - 28%)

Question

Quizplus · Accepted Answer

To calculate the taxable equivalent yield, we need to find the yield on a corporate bond that is equivalent to a municipal bond yield after adjusting for taxes. The formula to calculate taxable equivalent yield is r = rm / (1 - tax rate). In this case, the tax rate is 28%, so the correct formula is r = rm / (1 - 0.28) or r = rm / 0.72. The only option that matches this formula is D.

An Investor in a 28% Tax Bracket Is Trying to Decide