Assume that the only capital market imperfection is taxes. 

KayKay 

Industries currently has 

$ 100$100 

million invested in​ short-term Treasury securities paying 

7 % comma7%, 

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 that 

KayKay 

must pay a corporate tax rate of 

21 %21%​,

 investors pay no​ taxes, and there is no taxable gain from the sale of the securities.

**a.** If the board went ahead with this​ plan, what would happen to the value of 

KayKay 

stock upon the announcement of a change in​ policy?

**b.** What would happen to the value of 

KayKay 

stock on the​ ex-dividend date of the​ one-time dividend?

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

Question content area bottom

Part 1

**a.** If the board went ahead with this​ plan, what would happen to the value of 

KayKay 

stock upon the announcement of a change in​ policy? ** ​(Select the best choice​ below.)

A.

The value of 

KayKay 

would remain the same.

B.

The value of 

KayKay 

would rise by 

$ 100$100 

million.

C.

The value of 

KayKay 

would rise by 

$ 100 million times 0.21 equals $ 21 million$100 million×0.21=$21 million.

D.

The value of 

KayKay 

would fall by 

$ 100$100 

million.

Let's address each part of the problem step by step.

### Part a: What would happen to the value of KayKay stock upon the announcement of the policy change?

KayKay Industries currently has $100 million invested in short-term Treasury securities, earning a 7% return annually. This means KayKay is earning $7 million per year in interest, which it is currently paying out as dividends. The firm is subject to a 21% corporate tax rate, so the after-tax earnings from the interest are:

\[
\text{After-tax interest} = 7\% \times 100 \times (1 - 0.21) = 7 \times 0.79 = 5.53 \, \text{million per year}.
\]

Now, the firm is considering selling these securities and paying out the $100 million as a one-time dividend. 

1. **Selling the securities** means KayKay Industries would no longer earn the $5.53 million per year from the interest payments.
2. **Paying a one-time dividend** of $100 million does not generate any immediate tax effects for investors (as they pay no taxes), but the corporate value of the company changes based on its future cash flows.

Upon the announcement of the policy change:
- The value of the firm **should not change** immediately upon the announcement, since no cash has actually been paid out yet. The change in firm value is based on the cash flow after the dividend payment.

Thus, the value of **KayKay's stock should remain the same** upon the announcement.

### **Answer to part a:**
**A. The value of KayKay would remain the same.**

### Part b: What would happen to the value of KayKay stock on the ex-dividend date of the one-time dividend?

On the ex-dividend date, the $100 million dividend will be paid out to shareholders. Since the company is distributing $100 million in cash, the value of the firm will decrease by this amount. 

- Before the dividend, the stock price reflects the value of the company with its $100 million of cash.
- After the dividend, this $100 million is no longer part of the company's assets, so the stock price will drop by an amount equal to the dividend payment.

Thus, the value of **KayKay's stock will fall by $100 million** on the ex-dividend date.

### **Answer to part b:**
The value of **KayKay would fall by $100 million**.

### Part c: Given these price reactions, will this decision benefit investors?

Since investors pay no taxes, they would be indifferent between receiving dividends now or keeping their value in the firm. Here's why:

- If KayKay keeps the $100 million in Treasury securities, investors receive the after-tax interest of $5.53 million each year as dividends.
- If KayKay pays the $100 million as a one-time dividend, investors receive the cash immediately.

From a pure cash flow perspective, investors' wealth does not change based on this decision because their total value is preserved—either they receive dividends gradually from the interest or they receive the lump sum upfront.

Thus, this decision **does not create any extra benefit for investors**.

### **Answer to part c:**
The decision will **not benefit investors** in any meaningful way.

---

Would you like further details on any specific part?

Here are 5 related questions you might explore:
1. How do ex-dividend dates typically affect stock prices?
2. What are the effects of corporate tax rates on dividend policies?
3. How do investors' tax statuses influence dividend policy decisions?
4. How would the decision change if the company had debt obligations?
5. How does the Modigliani-Miller theorem relate to dividend policy in a no-tax world?

**Tip:** Always consider the tax implications and cash flow impacts when evaluating dividend policies, as they can influence both corporate decisions and investor outcomes.

Assume that the only capital market imperfection is taxes. KayKay Industries currently has $100 million invested in short-term Treasury securities paying 7%, 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 that KayKay must pay a corporate tax rate of 21%, investors pay no taxes, and there is no taxable gain from the sale of the securities. a. If the board went ahead with this plan, what would happen to the value of KayKay stock upon the announcement of a change in policy? b. What would happen to the value of KayKay stock on the ex-dividend date of the one-time dividend? c. Given these price reactions, will this decision benefit investors?

Explore how KayKay Industries' decision to sell $100 million of Treasury securities and pay a one-time dividend affects its stock value. Analyze dividend policy in a taxed corporate environment, using key formulas such as after-tax interest calculation and stock price drop. Suitable for undergraduate finance students.

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