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.Alternately they can pay a dividend and allow shareholders to make the investment.In perfect capital markets,which option will shareholders prefer?

Question

Quizplus · Accepted Answer

In perfect capital markets, the choice between immediate cash dividends and dividends paid after one year should not affect shareholders' preferences as they can invest the cash received in either case to replicate the other option. Therefore, shareholders should be indifferent between the two options. Option C, preferring half from each source, is also unlikely as it would introduce unnecessary transaction costs and inconvenience for shareholders. Option E, receiving most of the dividend now and the rest after a year, is also suboptimal as it introduces a time value of money consideration, which should not be a concern in perfect capital markets.

Palo Alto Enterprises Has $200,000 in Cash