Chapter 4, Problem 4TPC

Ms. Z has decided to invest $75,000 in state bonds. She could invest in State A bonds paying 5 percent annual interest or in State R bonds paying 5.4 percent annual interest. The bonds have the same risk, and the interest from both is exempt from federal income tax. Because Ms. Z is a resident of State A, she wouldn’t pay State A’s 8.5 percent personal income tax on the State A bond interest, but she would pay this tax on the State R bond interest. Ms. Z can deduct any state tax payments in the computation of her federal taxable income, and her federal marginal rate is 32 percent. Should Ms. Z invest in the State A or the State R bonds?