Suppose the board of a company decides to invest $250 million of cash in 1 year

Question

Suppose the board of a company decides to invest $250 million of cash in 1 year government bills yielding 4% and use the proceeds from the sale of the bills to pay a higher dividend next year.
A. What would be the company's share price in this case?
B. Compare the share price with the deferred dividend to the share price when the $250 million is immediately paid out in dividends. What can you conclude? Suppose the board of a company decides to invest $250 million of cash in 1 year government bills yielding 4% and use the proceeds from the sale of the bills to pay a higher dividend next year.
A. What would be the company's share price in this case?
B. Compare the share price with the deferred dividend to the share price when the $250 million is immediately paid out in dividends. What can you conclude?
A. What would be the company's share price in this case?
B. Compare the share price with the deferred dividend to the share price when the $250 million is immediately paid out in dividends. What can you conclude?

Explanation / Answer

A.

Dividend paid next year = $250 million * 1.04 = $260 million

Assuming the required rate of return equity to be same as rate of return on treasury bills i.e.4%

Share price = $260 million/4% = $6,500 million

B.

Share price = $250 million/4% = $6,250 million

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