# Chapter 7.pptx - Chapter 7 Investments 1 Instructed by...

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Chapter 7: Investments Instructed by: Kelly Wentland 1
Ch. 7 Videos Outline Lecture video 1 – broader tax treatment of income streams from investments Lecture video 2 – portfolio income review for a single capital asset and the netting process for multiple capital assets Lecture video 3 – wash sales and the net investment income expense 2
Broad investment decisions Objective: Often to maximize after-tax return To do this, you need to understand the tax consequences for how investments earn income. 3
Broad investment decisions That said, it is NOT always the case that the investment with the least tax is the best investment: E.g. – A municipal bond has interest income that is tax- exempt but it only pays a 3% interest rate (rate of return) while a corporate bond has interest income that is taxed but its after-tax rate of return is 5%. 4
Broad investment decisions Additionally, it is NOT always the case that the investment with the highest rate of pre-tax return is the best investment. E.g.: Investment A’s pre-tax rate of return is 10% but Investment B’s pre-tax rate of return is 9%. However, A is taxed at an ordinary tax rate, which happens to be a 32% marginal tax rate on that income for the taxpayer. In contrast, B is eligible for a preferential tax rate of 15%. A’s after-tax rate of return is: 6.8% (=10% x (1-32%)) B’s after-tax rate of return is: 7.65% (=9% x (1-15%)) 5
Broad investment decisions In-class exercise 1 – selecting investments : Investment A’s pre-tax rate of return is 10% but Investment B’s pre-tax rate of return is 9%. However, Investment A is taxed at an ordinary tax rate, which happens to be a 32% marginal tax rate on that income for the taxpayer. In contrast, Investment B is eligible for a preferential tax rate of 15%. Which investment should the taxpayer select (hint: which has the highest after-tax rate of return)? A’s after-tax rate of return is: 6.8% (=10% x (1-32%)) B’s after-tax rate of return is: 7.65% (=9% x (1-15%)) So, go with Investment B. 6
Broad investment decisions Thus, we focus on maximizing the after-tax rate of return which balances tax and non-tax elements of return and the trade-off of those features. If this were my graduate class (ACCT 708), I would actually say that we want to maximize the after-tax rate of return taking into account the time value of money (e.g., all else equal…the timing of tax also matters… paying later better). But, we won’t do time value of money (present value) comparisons for ACCT 351. 7
Savings accounts, CD, money market accounts The following only generate taxable income for the periodic interest payments (income) received: Savings account – a deposit account at bank (or other institution) that earns interest but that can be withdrawn/accessed quickly (at least to a point) Risk/return – low risk, low interest rate (return), but liquid.