Assume capital markets are perfect. Kay Industries has $125 million invested in short-term Treasury securities paying...

Assume capital markets are perfect. Kay Industries has $125 million invested in short-term Treasury securities paying 7%, and it pays out the interest payments on these securities each year as a dividend. The board is considering selling the Treasury securities and paying out the proceeds as a one-time dividend payment. Assume that Kay must pay a corporate tax rate of 40%, and investors pay no taxes.

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

A. The value of Kay would fall by $125 million.

B. The value of Kay would rise by $125 million.
C. The value of Kay would rise by $125 x 40% = $50 million.

D. The value of Kay would remain the same.

What would happen to the value of Kay stock on the ex-dividend date of the one-time dividend?

A. The value of Kay would rise by $125 million.

B. The value of Kay would remain the same.
C. It is difficult to tell because the price reaction depends on investor preferences.

D. The value of Kay would fall by $125 million.

Given these price reactions, will this decision benefit investors?

A. It is difficult to tell because the price reaction depends on investor preferences.

B. It will benefit investors.
C. It will hurt investors.

D. It will neither benefit nor hurt investors.

Solutions

Expert Solution

Ans:-

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

Option D. is correct

Reason:-

The declaration of profit does not influence the estimation of firm.
This is on account of it doesn't result in income.
Accordingly, upon declaration the estimation of firm will stay same.

What would happen to the value of Kay stock on the ex-dividend date of the one-time dividend?

Option D is correct

Reason:-

On ex-profit date the estimation of firm decreases by the measure of profit.
Along these lines, on ex-profit date the estimation of firm will diminish by the measure of treasury security.

Given these price reactions, will this decision benefit investors?

Option D is correct

Reason:-

On account of resigning exceptional security financial specialists get a lot of interest in single installment instead of getting as far as profits periodically.
Thus, the retirement of profit neither advantage nor hurt the speculators .

ekkarill92 answered 1 year ago

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