Palo Alto Enterprises has $300,000 in cash. They wish to invest the money in Treasury bills at 8% 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 35%, which option will shareholders prefer?

Question

Quizplus · Accepted Answer

Shareholders will prefer the immediate cash dividend because the corporate tax rate is 35% and investing in Treasury bills will result in taxable income for the corporation. Therefore, paying dividends from the cash balance will result in a lower tax burden for the shareholders compared to receiving returns from the Treasury bills.

Palo Alto Enterprises Has $300,000 in Cash