Interest Rates and Taxes: Practice Problems

Use the following Treasury rates to address questions 1-4:

3 month 1.89%

2 year 2.07

5 year 2.75

10 year 3.58

30 year 4.32

1)If a company can issue 30 year bonds at a 55 basis point spread over treasuries, what rate does it have to pay to the investor?

2)If expected inflation over the 5 year term is 2%, what is the Real Risk Free Rate for the 5 year term?

3)What is the Nominal Risk Free Rate for the 10 year term?

4)Calculate the spread over treasuries for bonds of the following companies, and the after tax cost of debt for these companies, assuming their marginal tax rate is 35%:

Company Maturity Pre-tax cost Spread over After tax

of borrowing Treasuries Cost of Debt

Wal-Mart 5 years 4.66%

Clorox 10 years 5.83

GE 30 years 5.11

5)For each corporate and municipal bond pair, decide which investment would be the best choice for you. Your objective is to maximize your return.

Bond Yield to Maturity Your Marginal Tax Rate

Corporation A 5.6% 25%

VT Municipal Bond 4.3%

Corporation B 4.9% 15%

VT Municipal Bond 4.0%

6) Given the tax rate schedule below, what is the marginal tax rate for Corporation XYZ?

A) If they have already earned $10,000,000 and then earn one more dollar of income?

B) If they have already earned $5,000,000 and then earn one more dollar of income?

Corporate Tax Rate Schedule:

Rate $ of Income

15% Up to $50,000

25% $50,001 - $75,000

34% $75,001 - $100,000

39% $100,001 - $335,000

34% $335,001 - $10,000,000

35% $10,000,001 15,000,000

38% $15,000,001 - $18,000,000

35% > $18,333,333