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Luther Industries has $5 million in excess cash and 1 million shares outstanding.Luther is considering investing the cash in one-year Treasury bills that are currently paying 5% interest and then using the cash to pay a dividend next year.Alternatively,Luther can pay the cash out as a dividend immediately and the shareholders can invest in the Treasury bills themselves.Assume that capital markets are perfect.
-If Luther invests the excess cash in Treasury bills,then the dividend per share next year will be closest to:
A)$5.00
B)$5.25
C)$4.75
D)$1.05

Question

Quizplus · Accepted Answer

If Luther invests the excess cash in Treasury bills, they will earn 5% on $5 million which is $250,000. If this amount is paid out as a dividend, the dividend per share will be $0.25 ($250,000/1,000,000 shares).

If Luther pays out the cash as a dividend immediately, the dividend per share will be $5.

Comparing the two options, the dividend per share will be higher if Luther pays out the cash as a dividend immediately. Therefore, the best choice is to pay out the cash as a dividend immediately.

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