Assume you are a tax planner for a client with the following concerns.
a. Suppose there exist three riskless assets. The first yields a fully taxable return of 7% before tax; the second yields a pretax return of 6%, only half of which is taxable; and the third yields a 5% fully tax exempt return. Over what range of tax rates does each asset yield the highest after tax return? How does this relate to tax clienteles?
b. Suppose the tax rate schedule is as follows: 20% on the first $ 5,000 of investment income, 30% on the next $ 5,000 of investment income, and 40% on investment income exceeding $ 10,000. If you had $ 150,000 to invest and you had to invest in only one of the three assets, which one would maximize after tax income?
c. Can you beat the investment strategy in (b) by investing in a portfolio of assets? What is the optimal investment (the one that maximizes after tax income) over the range of investment from $ 0 to $ 500,000?