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27 May, 21:17

Assume that Lucas's marginal tax rate is 32 percent and his tax rate on dividends is 16 percent. If a dividend-paying stock (with no growth potential) pays an 9.20 percent dividend yield, what interest rate would a municipal bond have to offer for Lucas to be indifferent between the two investments from a cash-flow perspective

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  1. 27 May, 21:48
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    The correct answer to the problem is 7.728%

    Explanation:

    Lucas marginal tax rate = 32 percent

    Tax rate on dividends = 16 percent

    Dividend yield of a dividend-paying stock (with no growth potential) = 9.20 percent.

    To determine the interest rate a municipal bond have to offer for Lucas to be indifferent between the two investments from a cash flow perspective =

    Dividend yield multiplied by (1 - tax rate on dividends)

    = 9.20% * (1 - 16%)

    = 0.092 * (1 - 0.16)

    = 0.092 * 0.84

    = 7.728%
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