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Palo Alto Enterprises has $200,000 in cash. They wish to invest the money in Treasury bills...

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

Select one:

A. immediate cash dividend

B. dividend after one year

C. prefer half from each source

D. indifferent between options

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Answer #1

A) immediate cash dividend

Repurchases do not change stock prices. So the question is whether the project has
positive NPV. NPV of the cash flows at the cost of capital equals 5 / 0.1 - 50 = 0.

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