Hugh has the choice between investing in a city of heflin bond at 6.60 percent investing in a surething bond at 10.00 percent. assuming that both bonds have the same nontax characteristics and that hugh has a 40 percent marginal tax rate, what interest rate does surething inc., need to offer to make hugh indifferent between investing in the two bonds?

Surething Inc, needs to issue bonds with 11% interest rate in order to make Hugh indifferent between investing in two bonds.

We arrive at the answer in the following manner:

The City of Helfin bonds are municipal bonds and hence they are tax free. This means that Hugh will get an after - tax return of 6.6%.

The bonds of Surething Inc offering a 10% interest, however are taxed at 40%. So, the current after-tax returns of the bond is:

Current after tax return = 0.06 or 6%

However Hugh will be indifferent to investing in these two bonds only if they offer the same after-tax return of 6.6%.

Given this, we can calculate the indifference rate as follows:

Pre-tax return = 0.11 or 11%.