16‐1

Part 6

Personal Investment Analysis

and Strategy
  16‐2

Chapter 16 Principles of Investing and Personal Income Tax

Income Taxes on Ordinary Income

16.1

a) Annual Espresso Expenditure = €2 × 365 days/year = €730 = $949

15 Years Dollars = $730 x 15 years = €10,950 = $14,235

b) After-Tax Income = $57,000 × (1 – 31.68%) = $38,942.40

Percentage of After-Tax Income = $949 / $38,942.40 = 2.437%

c) Pre-Tax Dollars = $57,000 × 2.437% = $1,389.05

Bond Investments After Tax

16.2

Marginal Tax Rate = 36%

Face Value = $2,000
Purchase Price = $1,800.00
Semiannual Interest Payments = ½($2,000 × 9%) = $90
Income Tax on Interest = 36% × $90 = $64.80
Capital Gains Tax on Sale = ($2,000 – $1,800) × 18% = $36
PW = –$1,800 + $90(P/A, i½, 12) – $64.80(P/A, ia, 6) + ($2,000 – $36)(P/F, i½, 12) = 0
Where i½ is the semiannual interest rate and ia = (1 + i½)2 – 1
Semiannual Rate (i½) = 3.8457%
After-Tax Annual Rate of Return (ia) = 7.8393%

Stock Investments After Tax

*
16.3
Total Capital Gains = ($175 – $45.50) × 1,000 shares = $129,500
Total Dividends = 10 years × 1,000 shares × $0.1 = $1,000
Note: Only her Capital Gains are taxed because her $10,000 salary + $100 dividend
income is less than the lowest federal bracket ($10,320) and the lowest provincial bracket
in Quebec ($13,069).

                                                            
*
An asterisk next to a problem number indicates that the solution is available to students on the
Companion Website.
 
  16‐3

Federal Bracket Rate Remaining Tax

$10,320 – $40,726 7.50% $119,180 $2,280.45
$40,726 – $81,452 11.00% $88,774 $4,479.86
$81,452 – $126,264 13.00% $48,048 $5,825.56
$126,264 and up 14.50% $3,236 $469.22
TOTAL FEDERAL: $13,055.09

Provincial Bracket (PEI) Rate Remaining Tax

$7,708 – $31,984 4.90% $121,792 $1,189.52
$31,984 – $63,969 6.90% $97,516 $2,206.97
$63,969 – $98,143 8.35% $65,531 $2,853.53
$98,143 and up 9.19% $31,357 $2,881.71
TOTAL PROVINCIAL: $9,131.73

Total Tax = $22,186.82

Total Proceeds = $129,500 + $1,000 – $22,186.82 = $108,313.18

Bond Investments After Tax

16.4
a) Marginal Tax Rate = 38.67%
Semiannual Interest Payments = ½($1,000 × 12%) = $60
Income Tax on Interest = 38.67% × $120 = $46.40
PW = –$1,000 + $60(P/A, i½, 60) – $46.40(P/A, ia, 30) + $1,000(P/F, i½, 60) = 0
Semiannual Rate (i½) = 3.7222%
After-Tax Annual Rate of Return (ia) = 7.5829%

b) The YTM of newly issued bonds for the investor is:

r = 9% × (1 – 38.67%) = 5.5197% per year compounded semiannually
i½ = 2.7599% per 6 months
ia = (1 + 2.7599%)2 – 1 = 5.5959% per year

c) To find the maximum price the investor is willing to pay, we need to use i½ =
2.7599% to analyze the cash flows of buying the bond on January 1, 2008.

P = $60(P/A, 2.7599%, 46) – $46.40(P/A, 5.5959%, 23) + $1,000(P/F, 2.7599%, 46)

P = $1,246.23

d) Capital Gains when redeemed = ½ × 38.67% ($1,000 – $922.38) = $15.01

PW = –$922.38 + $60(P/A, i½, 45) – $46.40(P/A, ia, 23) (1 + i½)

+ $60 × 38.67% (1 + i½)-1 + ($1,000 – $15.01)(P/F, i½, 45) = 0
  16‐4

Semiannual Rate (i½) = 4.0922%

After-Tax Annual Rate of Return (ia) = 8.3519%

e) Current Yield = $120(1 – 38.67%) / $922.38 = 7.9789%

16.5
Marginal Tax Rate = 34.75%
Income Tax on Interest = 34.75% × $95 = $33.01
Semiannual Rate (i½) = (1 + 7%)½ – 1 = 3.4408%
Semiannual Coupon Payments = ½($1,000 × 9.5%) = $47.50
PW = -$1,010 + $47.50(P/A, 3.4408%, 6) – $33.01(P/A, 7%, 3)
+ [S – ½ × 34.75% × (S – $1,010)](P/F, 7%, 3) = 0
S = $1,037.54

16.6
Marginal Tax Rate = 35%
Income Tax on Interest = 35% × $80 = $28
Semiannual Rate (i½) = (1 + 10%)½ – 1 = 4.8809%
Semiannual Interest Payments = ½($1,000 × 8%) = $40
PW = –$920 + $40(P/A, 4.8809%, 8) – $28(P/A, 10%, 4)
+ [S – ½ × 35% × (S – $920)](P/F, 10%, 4) = 0
S = $1,134.04
  16‐5

16.7
a) Purchase Price = $30(P/A, 4.5%, 10) + $1,000(P/F, 4.5%, 10) = $881.31

b) Marginal Tax Rate = 43.41%

Income Tax on Interest = 43.41% × $60 = $26.05
PW = -$881.31 + $30(P/A, i½, 10) – $26.05(P/A, ia, 5)
+ [$1,000 – ½ × 43.41% × ($1,000 – $881.31)](P/F, i½, 10) = 0

Semiannual Rate (i½) = 2.8725%

After-Tax Annual Rate of Return (ia) = 5.8275%

c) This 5.8275% is the after-tax ROR. It is lower than the required before-tax ROR
because we have to pay tax on any bond investment income in capital gains and
interest.

16.8
Marginal Tax Rate = 29.7%
Bond #1
PW = –$513.60 + [$1,000 – ½ × 29.7% × ($1,000 – $513.60)](P/F, ia, 5) = 0

Semiannual Rate (i½) = 6.0917%

After-Tax Annual Rate of Return (ia) =12.5545%
Bond #2
Income Tax on Interest = 29.7% × $113 × 2 = $67.12
PW = –$1,000 + $113(P/A, i½, 10) – $67.12(P/A, ia, 5) + $1,000(P/F, i½, 10) = 0
Semiannual Rate (i½) = 8.0741%
After-Tax Annual Rate of Return (ia) = 16.8002%
∴ The second bond would provide a higher yield.
  16‐6

16.9 *

Marginal Tax Rate = 32.5%

Semiannual Interest Payments = ½($1,000 × 15%) = $75
Income Tax on Interest = 32.5% × $150 = $48.75
PW = –$1,298.68 + $75(P/A, i½, 24) – $48.75(P/A, ia, 12)
+ [$1,000 – ½ × 32.5% × ($1,000 – $1,298.68)](P/F, i½, 24) = 0
Semiannual Rate (i½) = 3.3973%
After-Tax Annual Rate of Return (ia) = 6.9101%

16.10
a) Marginal Tax Rate = 36.0%
Semiannual Rate (i½) = 9%(1 – 36%) / 2 = 2.8800%
After-Tax Annual Rate of Return (ia) = 5.8429%
Income Tax on Interest = 36% × $200 = $72

Alpha Bond

PW = –Pα + $100(P/A, 2.8800%, 30) – $72(P/A, 5.8429%, 15)

+ [$1,000 – ½ × 36% × ($1,000 – Pα)](P/F, 5.8429%, 15) = 0
Pα = $1,770.07

Beta Bond

PW = –Pβ + $100(P/A, 2.8800%, 2) – $72(P/A, 5.8429%, 1)

+ [$1,000 – ½ × 36% × ($1,000 – Pβ)](P/F, 5.8429%, 1) = 0
Pβ = $1,082.48
b)
Alpha Bond

Pα = $100(P/A, 2.8800%, 30) + $1,000(P/F, 5.8429%, 15)

Pα = $1,895.89

Beta Bond
Pβ = $100(P/A, 2.8800%, 2) + $1,000(P/F, 5.8429%, 1)
Pβ = $1,103.00
  16‐7

16.11
Marginal Tax Rate = 34.8%
Income Tax on Interest = 34.8% × $87.50 = $30.45

a) PW = –$1,108 + $87.5(P/A, ia, 4) – $30.45(P/A, ia, 4)

+ [$1,000 – ½ × 34.8% × ($1,000 – $1,108)](P/F, ia, 4) = 0
After-Tax Annual Rate of Return (ia) = 3.2311%
b)
ia = {1 + ½ [9.5% × (1 – 34.8%)]}2 – 1 = 6.2899%
PW = –$1,035 + $87.5(P/A, 6.2899%, 4) – $30.45(P/A, 6.2899%, 4)
+ [$1,000 – ½ × 34.8% × ($1,000 – $1,035)](P/F, 6.2899%, 4)
PW = –$50.36 < 0
∴ No

16.12
Marginal Tax Rate = 36.5%

a) Semiannual Rate (i½) = 9%(1 – 36.5%) /2 = 2.8575%

After-Tax Annual Rate of Return (ia) = 5.7967%
PW = –P + $60(P/A, 2.8575%, 26) – $43.80(P/A, 5.7967%, 13)
+ [$1,000 – ½ × 36.5% × ($1,000 – P)](P/F, 5.7967%, 13) = 0
P = $1,195.89

b) Semiannual Rate (i½) = 13%(1 – 36.5%) /2 = 4.1275%

After-Tax Annual Rate of Return (ia) = 8.4254%
PW = –P + $60(P/A, 4.1275%, 26) – $43.80(P/A, 8.4254%, 13)
+ [$1,000 – ½ × 36.5% × ($1,000 – P)](P/F, 8.4254%, 13) = 0
P = $954.00

c) After-Tax Current Yield = $120(1 – 36.5%) / $783.58 = 9.7246%

  16‐8

Stock Investments After Tax

16.13 *

Dividend Tax Rate = 18.71%

Tax Payment on Dividends = 50¢ × 18.71% = 9.355¢/share/year
Marginal Tax Rate = 43.41%
Capital Gains Tax (End of Year 5) = ½(43.41%)($42.20 – $20.20) = $4.82
PW = –$20.20 + 0.50(1 – 18.71%)(P/A, ia, 5) + ($42.40 – $4.82)(P/F, ia, 5) = 0
After-Tax Annual Rate of Return (ia) = 14.8202%

16.14
Marginal Tax Rate = 43.41%
Dividend Tax Rate = 18.71%

The Trojan:

PW = –$1,020 + $65(P/A, i½, 20) – $ 56.43(P/A, ia, 10)

+ [$1,000 – ½ × 43.41% × ($1,000 – $1,020)](P/F, i½, 20) = 0
Semiannual Rate (i½) = 3.6014%, After-Tax Annual Rate of Return (ia) = 7.3326%

The Greek:

PW = –$980 + $50(P/A, i½, 20) – $43.41(P/A, ia, 10)

+ [$1,000 – ½ × 43.41% × ($1,000 – $980)](P/F, i½, 20) = 0
Semiannual Rate (i½) = 2.9793%, After-Tax Annual Rate of Return (ia) = 6.0475%

The Hera:

Capital Gains Tax = ½(43.41%)($30 – $10) = $4.34

PW = –$10 + 0.10(1 – 18.71%)(P/A, ia, 10) + ($30 – $4.34)(P/F, ia, 10) = 0
After-Tax Annual Rate of Return (ia) = 10.4354%

The Zeus:

Capital Gains Tax = ½(43.41%)($50 – $15) = $7.60

PW = –$15 + 0.02(1 – 18.71%)(P/A, ia, 10) + ($50 – $7.60)(P/F, ia, 10) = 0
After-Tax Annual Rate of Return (ia) = 11.0219%
∴ The Zeus provides the highest after-tax rate of return.

Bond Investments After Tax

16.15
  16‐9

a)
iSU3 yr  3 (1.01)(1.02)(1.03)  1  1.9967% / year

b)
iSU5 yr  5 (1.01)(1.02)(1.03)(1.0375)(1.0425)  1  2.7932% / year

(c) For the three-year term, the fixed rate savings bonds clearly provides a better
annual return. Since there is no five-year term for the fixed rate bonds, the
comparison is more difficult. However, if we assume a hypothetical five-year
fixed rate term would provide a rate that is the average of the three-year and
seven-year terms equivalent to 3.125%, then the fixed rate term would be superior
in this instance as well.

Stock Investments

16.16

Price Buy Sell Cash

$10,000.00
$4.00 2500 $0.00
$3.64 625 $2,275.00
$3.28 750 $4,735.00
$2.82 1675 $11.50
$3.72 2800 $10,427.50

∴ Dilan made $427.50

Dollar Cost Averaging

16.17

Date Price Shares

September 1, 2009 $81.21 12.31
October 1, 2009 $72.81 13.73
  16‐10

November 2, 2009 $60.15 16.63

December 1, 2009 $62.61 15.97
January 4, 2010 $68.74 14.55
February 1, 2010 $68.06 14.69
March 1, 2010 $73.47 13.61
April 1, 2010 $69.05 14.48
May 3, 2010 $72.19 13.85
June 1, 2010 $62.27 16.06
July 2, 2010 $51.11 19.57
August 3, 2010 $56.77 17.61

a) Total Stocks = 183.07

b) Break-Even Price = $66.54

Stock Investments

16.18

Date Price Shares Investment

January 4, 2010 $59.15 1,000 $59,150
February 1, 2010 $57.23 2,000 $114,460
March 1, 2010 $53.98 3,000 $161,940
April 1, 2010 $57.74 4,000 $230,960
May 3, 2010 $50.19 5,000 $250,950
June 1, 2010 $36.25 6,000 $217,500
July 1, 2010 $29.39 7,000 $205,730
August 2, 2010 $39.42 8,000 $315,360

Total Shares = 36,000

Total Investment = $1,556,050
Break-Even Price = $43.22
  16‐11 
Income Taxes on Ordinary Income

16.19

Year 0 1 2 3 4 5
Bank $100,000 $101,500 $103,023 $104,568 $106,136 $107,728
Income $200,000 $201,500 $203,023 $204,568 $206,136 $207,728

Federal Bracket Rate Remain Tax Remain Tax Remain Tax Remain Tax Remain Tax
$10,320 - $40,726 15.0% $191,180 $4,560.90 $192,703 $4,560.90 $194,248 $4,560.90 $195,816 $4,560.90 $197,408 $4,560.90
$40,726 - $81,452 22.0% $160,774 $8,959.72 $162,297 $8,959.72 $163,842 $8,959.72 $165,410 $8,959.72 $167,002 $8,959.72
$81,452 - $126,264 26.0% $120,048 $11,651.12 $121,571 $11,651.12 $123,116 $11,651.12 $124,684 $11,651.12 $126,276 $11,651.12
$126,264 $999,999 29.0% $75,236 $21,818.44 $76,759 $22,259.97 $78,304 $22,708.11 $79,872 $23,162.98 $81,464 $23,624.68
TOTAL FEDERAL: $46,990.18 $47,431.71 $47,879.85 $48,334.72 $48,796.42 $239,432.88

Nunavut Bracket Rate Remain Tax Remain Tax Remain Tax Remain Tax Remain Tax
$11,644 - $38,832 4.0% $189,856 $1,087.52 $191,379 $1,087.52 $192,924 $1,087.52 $194,492 $1,087.52 $196,084 $1,087.52
$38,832 - $77,664 7.0% $162,668 $2,718.24 $164,191 $2,718.24 $165,736 $2,718.24 $167,304 $2,718.24 $168,896 $2,718.24
$77,664 - $126,264 9.0% $123,836 $4,374.00 $125,359 $4,374.00 $126,904 $4,374.00 $128,472 $4,374.00 $130,064 $4,374.00
$126,264 $999,999 11.5% $75,236 $8,652.14 $76,759 $8,827.23 $78,304 $9,004.94 $79,872 $9,185.32 $81,464 $9,368.41
TOTAL NUNAVUT: $16,831.90 $17,006.99 $17,184.70 $17,365.08 $17,548.17 $85,936.84

TOTAL COMBINED: $63,822.08 $64,438.69 $65,064.55 $65,699.80 $66,344.58 $325,369.71

NWT Bracket Rate Remain Tax Remain Tax Remain Tax Remain Tax Remain Tax
$12,664 - $36,885 5.9% $188,836 $1,429.04 $190,359 $1,429.04 $191,904 $1,429.04 $193,472 $1,429.04 $195,064 $1,429.04
$36,885 - $73,772 8.6% $164,615 $3,172.28 $166,138 $3,172.28 $167,683 $3,172.28 $169,251 $3,172.28 $170,843 $3,172.28
$73,772 - $119,936 12.2% $127,728 $5,632.01 $129,251 $5,632.01 $130,796 $5,632.01 $132,364 $5,632.01 $133,956 $5,632.01
$119,936 $999,999 14.1% $81,564 $11,459.74 $83,087 $11,673.65 $84,632 $11,890.77 $86,200 $12,111.15 $87,792 $12,334.83
TOTAL
YELLOWKNIFE: $21,693.07 $21,906.98 $22,124.10 $22,344.48 $22,568.16 $110,636.80

TOTAL
YELLOWKNIFE-
NUNAVUT: $4,861.17 $4,899.99 $4,939.40 $4,979.40 $5,020.00 $24,699.96
  16‐12
Bond Investments After Tax

16.20

a) Muspelheim Rate of Return:

PW = –$10 + $0.20(P/A, ia, 5) + $45(P/F, ia, 5) = 0
Rate = 36.30%
Niflheim Rate of Return:
PW = –$5 + $0.10(P/A, ia, 5) + $15(P/F, ia, 5) = 0
Rate = 25.93%
∴ Muspelheim has a higher rate of return

b) Alberta Capital Gains Tax Rate @130k = 19.50%

Muspelheim Rate of Return:

PW = –$10 + $0.20[(1 – 3.68%)(P/F, ia, 1) + (1 – 3.68%)(P/F, ia, 2) + (1 – 10.21%)(P/F, ia, 3)

+ (1 – 10.21%)(P/F, ia, 4) + (1 – 14.56%)(P/F, ia, 5)]+ [$45 – (19.5% × $35)](P/F, ia, 5) =
0
Rate = 31.90%

Niflheim Rate of Return:

PW = –$5 + $0.10[(1 – 3.68%)(P/F, ia, 1) + (1 – 3.68%)(P/F, ia, 2) + (1 – 10.21%)(P/F, ia, 3)

+ (1 – 10.21%)(P/F, ia, 4) + (1 – 14.56%)(P/F, ia, 5)]+ [$45 – (19.5% × $15)](P/F, ia, 5) =
0
Rate = 23.79%
∴ Muspelheim has a higher rate of return

c) British Columbia Capital Gains Tax Rate @95k = 19.15%

Muspelheim Rate of Return:

PW = –$10 + $0.20[(1 – 3.68%)(P/F, ia, 1) + (1 – 3.68%)(P/F, ia, 2) + (1 – 12.07%)(P/F, ia, 3)

+ (1 – 12.07%)(P/F, ia, 4) + (1 – 12.07%)(P/F, ia, 5)]+ [$45 – (19.15% × $35)](P/F, ia, 5)
=0
Rate = 31.98%

Niflheim Rate of Return:

PW = –$5 + $0.10[(1 – 3.68%)(P/F, ia, 1) + (1 – 3.68%)(P/F, ia, 2) + (1 – 12.07%)(P/F, ia, 3)

+ (1 – 12.07%)(P/F, ia, 4) + (1 – 12.07%)(P/F, ia, 5)]+ [$45 – (19.15% × $15)](P/F, ia, 5)
=0
Rate = 23.86%
∴ Muspelheim has a higher rate of return
  16‐13
Stock Investments After Tax

16.21

a) Share-Price % Gain = [($20.50 – $13.85)/$13.85]*100% = 48.014%

b) Distribution RoR with Purchase Price = (12*0.15)/$13.85 = 12.996%

c) Distribution RoR with Sale Price = (12*0.15)/$20.50 = 8.780%

Federal Bracket Rate Remaining Tax

$10,320 – $40,726 15.0% $77,680 $2,280.45
$40,726 – $81,452 22.0% $47,274 $5,200.14
$81,452 – $126,264 26.0% $6,548 $851.24
TOTAL FEDERAL: $8,331.83

Provincial Bracket
(Yukon) Rate Remaining Tax
$10,320 – $40,726 7.04% $77,680 $1,070.29
$40,726 – $80,595 9.68% $47,274 $2,288.06
$80,595 – $81,452 10.16% $7,405 $376.17
$81,452 – $126,264 12.01% $6,548 $393.21
TOTAL PROVINCIAL: $4,127.73

d) Total Income Taxes: $12,459.56

Combined Dividend Rate = 10.87%
(Federal Dividend Rate = 10.20% + Provincial Dividend Rate = 0.67%)
Combined Capital Gains Rate = 19.01%
(Federal Capital Gains Rate = 13.00% + Provincial Capital Gains Rate = 6.01%)
For 2009:
Distributions = $6,000 (4 Months)
Distribution Tax = $6,000 × 10.87% = $652.20
Capital Gains = $0S
TOTAL: $13,111.76
For 2010:
Distributions = $10,500 (7 Months)
Distribution Tax = $10,500 × 10.87% = $1,141.35
Capital Gains = ($20.50 – $13.85) × 10,000 = $66,500
Capital Gains Tax = $66,500 × 19.01% = $12,641.65
TOTAL: $26,242.56
TOTAL TAXES: $39,354.33
  16‐14
Registered Retirement Savings Plans

16.22
Annual Withdrawal Upon Retirement = $40,000/75% = $53,333.33
First Withdrawal at Year 65: F65 = $53,333.33 (F/P, 4.2%, 35) = $225,096.58
Total Money Withdrawn During Retirement:

P65 = $225,096.58(P/A, 4.2%, 10%, 19) = $2,494,326.48

A = $2,494,326.48(A/F, 14.2%, 35) = $3,428.56
∴ Odin should invest $3,428.56 into his RRSPs on an annual basis.

Short Case Studies

ST16.1
No solution provided.

ST16.2
a) See GIC Taxes by Province graph

b) See Capital Gains Taxes by Province graph

c) See Dividend Taxes by Province graph

d) See Portfolio of Taxes by Province graph

  16‐15 
  16‐16 
  16‐17 
  16‐18