posted by Dantes on .
Consider a firm that has decided to make, but has
not yet announced, a large “bonus” cash dividend amounting in the aggregate to $5 million.
The firm has 1 million shares outstanding that sell for $20 each. The firm has no debt;
there are no taxes; and all transactions take place in a perfect capital market. Using calculations
like those in the illustration of dividend irrelevance in a perfect capital market, show that shareholders will be indifferent between whether the firm pays out the “bonus” as a
dividend or uses the money to buy back $5 million of its shares.