Question

Assume perfect capital markets. Kay Industries currently has

$ 150$150

million invested in​ short-term treasury bills paying

7 % comma7%,

and it pays out the interest payments on these securities as a dividend. The board is considering selling the treasury bills and paying out the proceeds as a​ one-time dividend payment. Assume that investors pay a

12 %12%

tax on dividends but no capital gains taxes and that Kay does not pay corporate taxes.

a. If the board went ahead with this​ plan, what would happen to the value of​ Kay's stock upon the announcement of a change in​ policy?

b. What would happen to the value of​ Kay's stock on the​ ex-dividend date of the​ one-time dividend?

c. Given these price​ reactions, will this decision benefit​ investors?

Answer 1

Requirement a

The announcement of change in policy will highly trigger the share price in upward direction. The dividend is paid one time, which the investors would be more intrested in near return compared to previous policy of distributed future returns.

Requirement b

The ex-dividend price would be higher. After the receipt of dividend, the share price will fall down drastically.

Requirement c

There is a huge opportunities for investors to end up at high profits if they plan and invest at right time, due to huge variation in share price.