Roy decides to buy a personal residence, and he goes to the bank for a $150,000 loan. The bank tells Roy that he can borrow the funds at 4% if his...
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Roy decides to buy a personal residence, and he goes to the bank for a $150,000 loan. The bank tells Roy that he

can borrow the funds at 4% 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%. Hal agrees to either of the following.

  • Roy borrows from the bank with Hal's guarantee provided to the bank.
  • 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 source of income is his salary, is in the 12% marginal tax bracket. The interest that Roy pays on the mortgage will be deductible by him.

Considering only the tax consequences, answer the following.

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 $ before taxes and $ after taxes.

This arrangement would produce an overall negative 


 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 would be $.

Roy's tax benefit from the imputed interest expense from Hal's loan would be $.

This arrangement would produce an overall negative 


 cash flow after taxes to the family of $.

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