National Business Machines (NBM) has $3 mil of surplus cash after taxes have been paid and are considering two choices for its use. Alternative one is to invest the cash in financial assets with the resulting investment income being paid out as a special dividend at the end of three years. The choice of financial assets are: 1) Treasury bills yielding 3% for preferred stock of Plum Computers Co. that yields 5%. IRS regulations allow NBM to exclude from taxable income 70% of dividends received from investing in another companys stock.

The second alternative use for NBMs surplus cash is to pay it out now as a special cash dividend and allow investors to invest on their own choosing between Treasury bills and the preferred stock issued by Plum Computer Co. NBMs corporate tax rate is 35% and NMBs shareholders that would receive the dividend have a 31% tax rate which applies to interest and preferred dividend income. However, the personal tax rate on common stock dividends is 15%.

Should the cash be paid today or in three years? Which of the two options generates the highest after tax return for shareholders?