The corporate treasurer of Howards Fireworks is considering the purchase of a BB+ rated bond that carries a coupon of 12 percent. The BB+ rated security is taxable, and the firm is in the 21 percent marginal tax bracket.

The face value of this bond is A$1,000.

A financial analyst who reports to the corporate treasurer has alerted him to the fact that a municipal obligation is coming to the market with a 8.5 percent coupon. The par value of this security is also A$1,000.

a. Which one of the two securities do you recommend the firm purchase? Why?

b. What must the fully taxed bond yield before tax to make it comparable with the municipal offering?