How do I do this assignment?
Question:
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 = 5%.
•Municipal bonds - expected annual yield = 5%.
•High-yield corporate stocks - expected dividend yield = 8%.
•Savings account in a commercial bank-expected annual yield = 3%.
•High-growth common stocks - expected annual increase in market value = 10%; expected dividend yield = 0.
1.Calculate the after-tax yields on the foregoing investments, assuming the Brittens have a 28% marginal tax rate
Answer:
You have to know the applicable tax rates on each of the investments.
municple bonds is 0%
high growth stocks as long as you do not sell is also 0% but the tax bill will come due when they are sold.
Condominimum is also 0%, and there is also a tax advantage to investing in the cond. The interest on the mortgage is subtracted from taxable income if the couple has more than $10,000 in deductions.
Dividends are taxed at about 1/2 the normal tax rate for most common stocks but not all.
Saving account interest is fully taxed.
What you need to know but have not stated is the mortgage interest rate.
Also you need to know the expected growth rate of the high yield corpartate stocks which is not given. Many times they outperform growth stocks.
After tax returns:
municples 5%
condo 5% +++ because of mortgage interest maybe 7%
high growth stocks 10% provided they are never sold
savings account 2.16% less inflation at 4% nets -1.84%
high yield corporate stock 6.8% +- plus capital gains of maybe another 5% which was not given in the problem.
Hey Phy:
Condo 5% no tax until you sell it
Munis 5% no tax at all
Hi yield stocks 8%-28%=5.76%
Savings acct 3%-28%=2.16%
Hi growth stock 10% no tax till you sell it
Welll, this is a toughie. I mean it's easy to do the calculations, but there are other real-life issues. However, here are the calculations:
1. Condo: $100,000 x .05 = $5,000.00; In this case, the condo is expected to be worth $105,000 one year after they purchase it. So, they will have a paper gain, or a gain in market value, of $5,000. Unless they then sell the condo, this is not a taxable gain. It is simply a gain in market value. It only becomes a taxable gain if they actually sell it at that price. Market values go up and they go down, depending on the economy, and supply and demand.
2. Muni bonds: You don't show how much they are investing. But, if they buy the condo, they have $30,000 remaining to be invested. ($40,000 - $10,000 down payment on condo = $30,000). So, assuming they invest $10,000 in munis, then the calculation is $10,000 x .05 = $500.00. Muni bond interest is considered tax-exempt (non-taxable) by the IRS. (It might or might not be taxable at the state level; that depends on which state). So, most people then figure out what the comparable taxable rate would be. To do that, you take the tax-exempt interest rate and divide it by 1 minus the tax rate: .05 / (1-.28) = .05 / .72 = .0694
Round this off to 7%. So, for this couple, 5% tax-exempt interest is equivalent to 7% taxable interest. So, this couple would earn $500, but it's worth 7% to them when they take their tax rate into consideration, since they don't have to pay taxes on it. Nonetheless, on an after-tax basis, the yield is still 5%.
3. Hi yield stocks: Let's says $10,000 is invested, so $10,000 x .08 = $800 dividend income. If the stock is a US stock, the maximum tax on the dividend income is 15%. So, this dividend income is sectioned off from other income and taxed at just 15%. So, $800 x .15 = $120 taxes owed to IRS. This couple gets to keep $800 - $120 = $680. Then, $680 / $10,000 = 6.8% after-tax yield.
4. Savings: $10,000 x .03 = $300. Taxed at 28% marginal rate. So, $300 x .28 tax rate = $84 taxes owed to IRS. After-tax income is $300 - $84 = $216. Then, $216 / $10,000 = 2.2% after tax yield. So, after paying the tax, this couple really earned $216 on their investment of $10,000, making it a yield of 2.2%.
5. Growth stocks: There is no dividend income and therefore no tax to be paid. It's like the condo above. It's a paper profit of 10%, but it's only taxable when the stock is sold. And then it depends on how long the stock was owned.
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