Question

Assume capital markets are perfect. Kay Industries currently has

$100 million invested in shortterm 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.
a. 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?
b. What would happen to the value of Kay stock on the ex-dividend date of the one-time dividend?
c. Given these price reactions, will this decision benefit investors?
Redo Problem above, but assume the following:
a. Investors pay a
15% tax on dividends but no capital gains taxes or taxes on interest income, and Kay does not pay corporate taxes.
b. Investors pay a
15% tax on dividends and capital gains, and a
35% tax on interest income, while Kay pays a
35% corporate tax rate.

Answer 1

If Kay Industries sells the Treasury securities and pays a one-time dividend, the value of Kay stock would decrease upon the announcement and further on the ex-dividend date. This decision may not benefit investors due to potential capital losses.

Step-by-step explanation:

a. If the board went ahead with this plan, the value of Kay stock would decrease upon the announcement of a change in policy. This is because investors expect to receive a rate of return, which can come in the form of dividends or capital gains. By selling the Treasury securities and paying out the proceeds as a one-time dividend, Kay Industries would no longer be able to provide future dividend payments, which would reduce investor confidence and decrease the stock value.

b. On the ex-dividend date of the one-time dividend, the value of Kay stock would decrease further. This is because when a stock goes ex-dividend, it means that investors who buy the stock on or after that date are not entitled to receive the upcoming dividend payment. As a result, the stock price typically drops by an amount equal to the dividend payment.

c. Given these price reactions, this decision may not benefit investors. Selling the Treasury securities and paying out the proceeds as a one-time dividend may lead to a decrease in stock value, potentially resulting in capital losses for investors.