Palo Alto Enterprises has $100,000 in cash.They wish to invest the money in Treasury bills at 6% 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, shareholders should be indifferent between receiving an immediate cash dividend or a dividend after one year as they can invest their own money in Treasury bills, earning the same 6% return as the company. Similarly, if the company decides to reinvest the cash in Treasury bills, shareholders can make the same investment themselves and earn the same return. Hence, the shareholders should be indifferent between the two options. Therefore, option D is the correct answer.

Palo Alto Enterprises Has $100,000 in Cash