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

Why B — 5.15%

Tax-equivalent yield = Tax-exempt yield / (1 - Tax rate) = 3.5% / (1 - 0.32) = 3.5% / 0.68 = 5.15%. This means the investor would need a corporate bond yielding at least 5.15% to match the after-tax return of the 3.5% municipal bond. The higher the tax bracket, the more valuable the municipal bond's tax exemption becomes. Answer C (2.38%) is the result of incorrectly multiplying by (1 - tax rate) instead of dividing.