A taxpayer asks Steve to help assess two different investment options that are exposed to similar risk.
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Question:
A taxpayer asks Steve to help assess two different investment options that are exposed to similar risk. Assume that if any of the investments are taxed on their return it is taxed annually and the cost of the investment is not deductible. Below is a table that lays out the pre-tax rates of return and tax treatment with each of the two investments.
Investment | Taxed? | Pre-tax rate of return per annum |
A | Tax-exempt | 5% |
B | Fully taxed | 8% |
Part A: At what tax rate will the taxpayer be indifferent between A and B?
Part B: Ignoring your answer to Part A, assume that the tax rate where the taxpayer is indifferent between A and B is 15%, which investment should the taxpayer choose if her tax rate is lower than this at 10%?
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