The after tax yields on foregoing investments can be calculated by using the following formula.
After tax yield = pre-tax yield (1 – tax rate)
The pretax yield on corporate taxes is 5% and the after tax yield is obtained by applying the formula.
After Tax Yield = 5% (1 – 28%)
After Tax Yield = 3.6%
The pretax yield on corporate taxes is 1% and the after tax yield is calculated by using the formula.
After Tax Yield = 1% (1 – 28%)
After Tax Yield = 0.72%
The best strategy for the couple is to purchase the condominium by paying down payment to save current rental expenses which can also be reinvested. The couple should invest the remaining $30,000 in several options for the purpose of risk diversification. A portion of the $30,000 will be invested in municipal bonds due to low risk factor and a stable yield of 5%. Investing in high growth common stocks would increase the overall earnings as they appreciate by 6% in value resulting in a capital gain and taxes would be lower as the Jobs and Growth Tax Relief Reconciliation Act of 2003 decreased the tax rate on capital gains (U.S. Congress, 2003). The rental expense saved by shifting to the condominium should be invested in corporate stocks with a high after tax yield of 3.6%. After 10 years the couple can sell off all their investments to receive a significant gain on their $40,000 investment.
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