Assume capital markets are perfect. Kay Industries currently has $100 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 35%, and investors pay no taxes.

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

1. The value of Kay would rise by $10035%=$35 million

2. The value of Kay would rise by $100 million.

3. The value of Kay would fall by $100 million.

4. The value of Kay would remain the same.

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

c. Given these price reactions, will this decision benefit investors?

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