An investor in the 32% federal tax bracket is comparing a municipal bond yielding 3.5% to a corporate bond. What is the tax-equivalent yield of the municipal bond?

Why B — 5.15%

Tax-equivalent yield = Municipal yield / (1 - Tax rate) = 3.5% / (1 - 0.32) = 3.5% / 0.68 = 5.15%. This means a corporate bond would need to yield at least 5.15% before taxes to provide the same after-tax return as the 3.5% tax-exempt municipal bond. The higher the investor's tax bracket, the more attractive municipal bonds become on a tax-equivalent basis.