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. In perfect capital markets, which option will shareholders prefer?

Question

Quizplus · Accepted Answer

In a perfect capital market, shareholders would be indifferent between receiving an immediate cash dividend or a dividend after one year. The total return they receive would be the same in both cases, as they can use the same amount of cash to invest in Treasury bills and earn the same 5% return as the company would. Therefore, shareholders would be content with either option and would not have a clear preference between them. Some shareholders may prefer a mixture of both options (option C), but this would not affect the overall outcome.

Palo Alto Enterprises Has $200,000 in Cash