a. After completing its capital spending for the year, HSU Manufacturing has $1,000

extra cash. HSUs managers must choose between investing the cash in Treasurybonds that yield 8% or paying the cash out to investors who would invest in the bonds themselves.

1. If the corporate tax rate is 35%, what personal tax rate would make the investors equally willing to receive the dividend or to let HSU invest the money? (10 marks)

2. Is the answer to part i) reasonable? Explain. (2 marks)

b. The desire for high current income is a valid explanation of preference for high current

dividend policy. Comment on the validity of this statement. (11 marks)