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.If corporate tax rates are 30%,which option will shareholders prefer in perfect capital markets?

Question

Quizplus · Accepted Answer

Shareholders should be indifferent between receiving an immediate dividend and being paid a dividend after one year through investing in Treasury bills. This is because in perfect capital markets, the value of the investment and the dividend payout should be the same, whether the company makes the investment or the shareholders make the investment. The corporate tax rate also does not affect this decision. Therefore, shareholders may choose either option based on their personal preferences or investing strategy.

Palo Alto Enterprises Has $200,000 in Cash