Suppose Genron does not adopt the third alternative policy and instead pays a $2 dividend per share today. Show how an investor holding 2000 shares could create a homemade dividend of $4.50 per share × 2000 shares = $9000 per year on her own.

Question

Accepted Answer

Plan

If Genron pays a $2 dividend, the investor receives $4000 in cash and holds the rest in stock. She can raise $5000 in additional cash by selling 125 shares at $40 per share just after the dividend is paid.

Execute

The investor creates her $9000 this year by collecting the $4000 dividend and then selling 125 shares at $40 per share. In future years, Genron will pay a dividend of $4.80 per share. Because she will own 2000 - 125 = 1875 shares, the investor will receive dividends of 1875 × $4.80 = $9000 per year from then on.

Evaluate

Again, the policy that the firm chooses is irrelevant—the investor can transact in the market to create a homemade dividend policy that suits her preferences.

Question 17.1: Suppose Genron does not adopt the third alternative policy a...

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