DIVIDEND POLICY. Erickson Company is a closely held corporation (the stock is owned by a small number of individuals). Erickson’s board is trying to decide whether to pay $500,000 to stockholders in dividends or to keep the cash and invest it in promising projects that have been identified by management. Nearly all of Erickson’s shareholders are wealthy individuals who would pay tax at the rate of 31% on any dividends that were paid to them. These investors could probably invest any excess cash that they have in opportunities that would earn 20% before taxes. If Erickson retains the $500,000, it would probably earn 15% before taxes. Erickson’s income tax rate is 34%.

REQUIRED:

Would the stockholders be better off in 1 year if Erickson paid the $500,000 in dividends or kept the money for 1 year and then paid to the shareholders $500,000 plus any amount that it had earned after corporate income taxes?