Assume capital markets are perfect. Kay industries currently has

$100

million invested in short-term securities paying

6%,

and it pays out the interest payments on these securities as a dividend. The board is considering selling the Treasury securities and paying out the proceeds as a one-time dividend payment. Assume investors pay a

12%

tax on capital gains and a

21%

tax on interest income, while Kay pays a

21%

corporate tax rate.

a. If the board went ahead with this plan, what would happened to the value of Kay stock upon announcement of a change in policy? (Hint: Use equation 17.7 to determine the current effective tax disadvantage of retaining cash.)

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?