Finance Concepts: After-Tax Yields On Investments
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Bernie and Pam Britten are a young married couple beginning careers and establishing a household. They will each make about $50,000 next year and will have accumulated about $40,000 to invest. They now rent an apartment but are considering purchasing a condominium for $100,000. If they do, a down payment of $10,000 will be required.
They have discussed their situation with Lew McCarthy, an investment advisor and personal friend, and he has recommended the following investments:
The condominium - expected annual increase in market value = 2%.
Municipal bonds - expected annual yield = 3%.
High-yield corporate stocks - expected dividend yield = 5%.
Savings account in a commercial bank-expected annual yield = 1%.
High-growth common stocks - expected annual increase in market value = 6%; expected dividend yield = 0.
Required:
1. Calculate the after-tax yields on the foregoing investments, assuming the Brittens have a 28% marginal tax rate (based on Public Law 108-27, The Jobs and Growth Tax Relief Reconciliation Act of 2003).
2. How would you recommend the Brittens invest their $40,000? Explain your answer.
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Solution Summary
The solution provides detailed explanations and analysis of the investment options.
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1. Condominium: If this is Bernie and Pam's first home then they should be excluded from paying capital gain tax. As the condominium appreciates there will be no tax consequences as the gain is not being realized. So the after-tax yield would be 2% (assuming this is their first home).
Municipal bonds: this is exempt from tax, so the after-tax yield is ...
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