Palo Alto Enterprises has $200,000 in cash. They wish to invest the money in Treasury bills at 5% and use the returns to pay dividends to shareholders after a year. Alternatively they can pay a dividend and allow shareholders to make the investment. If corporate tax rates are 30%, which option will shareholders prefer in perfect capital markets?

Question

Quizplus · Accepted Answer

In perfect capital markets, shareholders are indifferent between receiving dividends now or later due to the dividend irrelevance theory. Taxes and transaction costs do not affect this decision, as shareholders can replicate the firm's investment strategy on their own.

Palo Alto Enterprises Has $200,000 in Cash