Question 7.R: The income tax-free yield on a certain municipal bond is 7% ...

Engineering Economy [EXP-20136]

The income tax-free yield on a certain municipal bond is 7% per year. This translates into approximately a 5% annual yield if the municipal bond’s interest had been taxable in the 28% income tax bracket [7% (1 – 0.28) approx. = 5%]. Compare the future worth of the two situations (i.e., nontaxable versus taxable interest) when $15,000 is deposited annually for 30 years. What is the learning “take away” of this problem? (7.9)

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Non-taxed: $F_{1}$ = $15,000 (F/A, 7%, 30) = $15,000 (94.4608) = $1,416,912

Taxed: $F_{2}$ = $15,000 (F/A, 5%, 30) = $15,000 (66.4388) = $996,582

$F_{1}$ is greater than $F_{2}$ by 42%. The lesson is to invest in tax-free securities when they are prudent.

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