Gorden Co. has $6 million of extra cash after taxes have been paid. The company has two choices to make use of this cash. One alternative is to invest the cash in preferred stock of another company. The preferred stock pays 5,3% dividend at the end of every year. The resulting investment income will be paid out as a dividend at the end of next year. IRS regulations allow the company to exclude from taxable income 50 percent of the dividends received from investing in another companys stock. Another alternative is to pay out the cash now as dividends. This would allow the shareholders to invest on their own in preferred stock. The corporate tax rate is 21 percent. Assume the investor has a 33 percent personal income tax rate, which is applied to preferred stock dividends. The personal dividend tax rate is 15 percent on common stock dividends.

1. Suppose the company reinvests the $6 million and pays a dividend next year. What is the total aftertax cash flow to shareholders if the company invests in preferred stock?

2. Suppose instead that the company pays a $5.1 million dividend now and the shareholder reinvests the dividend for three years. What is the total aftertax cash flow to shareholders if the shareholder invests in preferred stock?

3. Under the light of your results, please comment this phenomenon by referring to Dividend irrevelance theorem.