Thevalueofcashthatisinvestedatalowerrateis$133.33
million. In this scenario, if the cash is returned to
stockholders,itwouldyieldthemasurplusvalueof$66.67
million.Infact,liquidating anyasset thathasa returnless
thantherequiredreturnwouldyieldthesameresult,aslong
as the entire investment can be recovered on liquidation.
22
Distrust of Management
While making a large investment in low-risk or riskless
marketablesecuritiesbyitselfisvalueneutral,aburgeoning
cashbalancecantemptmanagerstoacceptlargeinvestments
or make acquisitions even if these investments earn
substandard returns. In some cases, these actions may be
taken to prevent the firm from becoming a takeover target.
23 Totheextentthatstockholdersanticipatesuchsubstandard
investments,thecurrentmarketvalueofthefirmwillreflect
thecashatadiscountedlevel. Thediscountislikely tobe
largestatfirms withfewinvestmentopportunitiesand poor
management, andthere maybe nodiscountatallin firms
with significant investment opportunities and good
management.
ILLUSTRATION10.4:DiscountforPoorInvestmentsinthe
Future
ReturnnowtothefirmdescribedinIllustration10.1,where
thecashisinvestedattherisklessrateof4.5%.Normally,we
wouldexpecttheequityinthisfirmtotradeatatotalvalueof
$1,400million.Assume,however,thatthemanagersofthis
firmhaveahistoryofpooracquisitionsandthatthepresence
ofalargecashbalanceincreasestheprobabilityfrom0%to