Roy decides to buy a personal residence and goes to the bank for a $150,000 loan. The bank tells him that he can borrow the funds at 4% if his father will guarantee the debt. Roy's father, Hal, owns a $150,000 CD currently yielding 3.5%. The Federal rate is 3%. Hal agrees to either of the following: Roy borrows from the bank with Hal's guarantee to the bank. Hal cashes in the CD (with no penalty) and lends Roy the funds at 2% interest. Hal is in the 32% marginal tax bracket. Roy, whose only source of income is his salary, is in the 12% marginal tax bracket. The interest Roy pays on the mortgage will be deductible by him. Considering only the tax consequences, answer the following. a. The loan guarantee: Hal's interest income from the CDs would be $ before taxes and $ after taxes. Roy's interest expense from the bank loan would be $ before taxes and $ after taxes. This arrangement would produce an overall cash flow after taxes to the family of $. b. The loan from Hal to Roy: Hal's tax on the imputed interest income from the loan to Roy would be $. Roy's tax benefit from the imputed interest expense from Hal's loan would be $. This arrangement would produce an overall cash flow after taxes to the family of $. c. Which option will maximize the family's after-tax wealth?
Roy decides to buy a personal residence and goes to the bank for a $150,000 loan. The bank tells him that he can borrow the funds at 4% if his father will guarantee the debt. Roy's father, Hal, owns a $150,000 CD currently yielding 3.5%. The Federal rate is 3%. Hal agrees to either of the following:
- Roy borrows from the bank with Hal's guarantee to the bank.
- Hal cashes in the CD (with no penalty) and lends Roy the funds at 2% interest.
Hal is in the 32% marginal tax bracket. Roy, whose only source of income is his salary, is in the 12% marginal tax bracket. The interest Roy pays on the mortgage will be deductible by him.
Considering only the tax consequences, answer the following.
a. The loan guarantee:
Hal's interest income from the CDs would be $ before taxes and $ after taxes.
Roy's interest expense from the bank loan would be $ before taxes and $ after taxes.
This arrangement would produce an overall cash flow after taxes to the family of $.
b. The loan from Hal to Roy:
Hal's tax on the imputed interest income from the loan to Roy would be $.
Roy's tax benefit from the imputed interest expense from Hal's loan would be $.
This arrangement would produce an overall cash flow after taxes to the family of $.
c. Which option will maximize the family's after-tax wealth?
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