which bond would be prefer?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Question
![### Bond Investment Decision
**Problem Statement:**
Pete "Polar Bear" Alonso wants to purchase a bond with the highest tax-affected yield. He has a choice between a New York City municipal bond yielding 4.09% or a AAA-rated Coca Cola bond yielding 4.38%. His tax rate is 30%. Assuming the Polar Bear is rational (and that is a stretch), which bond would he prefer?
**Options:**
a) Neither, as he doesn’t understand how to calculate tax-affected yields
b) New York City bond
c) Both, tax-affected yield is exactly the same
d) Coca Cola
e) His tax bracket is wrong
### Explanation:
To determine which bond Pete should prefer, we need to calculate the tax-affected yield for each bond. Here's how we can approach this:
1. **New York City Municipal Bond:** Typically, municipal bonds are exempt from federal taxes. Therefore, the tax-affected yield remains 4.09%.
2. **Coca Cola Bond:** This bond's yield will be affected by his tax rate. The formula to calculate the tax-affected yield is:
\[
\text{Tax-affected yield} = \text{Yield} \times (1 - \text{Tax rate})
\]
By applying the given yield and tax rate:
\[
\text{Tax-affected yield} = 4.38\% \times (1 - 0.30) = 4.38\% \times 0.70 = 3.066\%
\]
Since the tax-affected yield of the New York City municipal bond (4.09%) is higher than the tax-affected yield of the Coca Cola bond (3.066%), Pete should prefer the New York City bond.
Therefore, the correct answer is:
**b) New York City bond**](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fc0c85ab8-b1cf-40a5-a93b-8f102a3fc8f5%2Fe6be14af-f93f-4100-9139-6ff591457caa%2Fgirk3mu_processed.jpeg&w=3840&q=75)
Transcribed Image Text:### Bond Investment Decision
**Problem Statement:**
Pete "Polar Bear" Alonso wants to purchase a bond with the highest tax-affected yield. He has a choice between a New York City municipal bond yielding 4.09% or a AAA-rated Coca Cola bond yielding 4.38%. His tax rate is 30%. Assuming the Polar Bear is rational (and that is a stretch), which bond would he prefer?
**Options:**
a) Neither, as he doesn’t understand how to calculate tax-affected yields
b) New York City bond
c) Both, tax-affected yield is exactly the same
d) Coca Cola
e) His tax bracket is wrong
### Explanation:
To determine which bond Pete should prefer, we need to calculate the tax-affected yield for each bond. Here's how we can approach this:
1. **New York City Municipal Bond:** Typically, municipal bonds are exempt from federal taxes. Therefore, the tax-affected yield remains 4.09%.
2. **Coca Cola Bond:** This bond's yield will be affected by his tax rate. The formula to calculate the tax-affected yield is:
\[
\text{Tax-affected yield} = \text{Yield} \times (1 - \text{Tax rate})
\]
By applying the given yield and tax rate:
\[
\text{Tax-affected yield} = 4.38\% \times (1 - 0.30) = 4.38\% \times 0.70 = 3.066\%
\]
Since the tax-affected yield of the New York City municipal bond (4.09%) is higher than the tax-affected yield of the Coca Cola bond (3.066%), Pete should prefer the New York City bond.
Therefore, the correct answer is:
**b) New York City bond**
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