oy decides to buy a personal residence and goes to the bank fora $150,000 loan. The bank tells him that he can borrow the funds at4% if his father will guarantee the debt. Roy's father, Hal, owns a$150,000 CD currently yielding 3.5%. The Federal rate is 3%. Halagrees to either of the following:
- Roy borrows from the bank with Hal's guarantee to thebank.
- Cash in the CD (with no penalty), and lend Roy the funds at 2%interest.
Hal is in the 32% marginal tax bracket. Roy, whose only sourceof income is his salary, is in the 12% marginal tax bracket. Theinterest Roy pays on the mortgage will be deductible by him.
Considering only the tax consequences, answer thefollowing. If required, round the interim calculation for the taxon interest income to the nearest dollar. Final answers should berounded to the nearest dollar, if required.
a. The loan guarantee:
Hal's interest income from the CDs would be $ before taxes and $after taxes.
Roy's interest expense from the bank loan would be $ beforetaxes and $ after taxes.
This arrangement would produce an overallnegative cash flow after taxes to the family of $.
b. The loan from Hal to Roy:
Hal's tax on the imputed interest income from the loan to Roy wouldbe $.
Roy's tax benefit from the imputed interest expense from Hal'sloan would be $.
This arrangement would produce an overallnegative cash flow after taxes to the family of $.
c. Which option will maximize the family'safter-tax wealth?
The loan from Hal to Roy
