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

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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