Financing, investment and separationmore wealth than £10,000, but if it is not to be available to spend when it is wanted or
needed, the £10,000 may be preferred. It seems impossible to maximise the satisfaction
that each shareholder gets from the business: satisfying some dissatisfies others
because timing of spending matters to people, but not to each person in the same way.Borrowing and lending
If we introduce a bit more realism into the example by assuming that both Industries
Ltd and its shareholders can borrow and lend money, management’s dilemma dis-
appears. To illustrate this, let us assume that the interest rate is 10 per cent p.a. and see
how the introduction of borrowing and lending affects the position of the trio if Project
X is undertaken.l Eager, who wants her money now, could borrow from the bank such an amount
that would, with interest, grow to £12,000 by next year. The borrowings could then
be discharged using the cash from the dividend to be received in a year’s time. The
borrowed amount would be £10,909, that is, £12,000 ×100/(100 +10) [check: £10,909
+(10% ×£10,909) =£12,000]. Thus she could immediately have £909 more to spend
than if Project X were to be rejected by the business. Of course, she would still owe
the bank £12,000 by the end of the year, but she would use her dividend to pay this.
l Patient, who prefers to wait the year, will receive and spend his £12,000 in a year’s
time. If Project X were to be rejected, the best that he could do would be to lend the
£10,000 dividend to the bank, which, with interest at 10 per cent, would grow to
£11,000 over the year.
l Steady, who needs her money in six months’ time, could at that time borrow such
an amount as will grow with interest to £12,000 by the end of the year. Since she
does not need the money during the first six months she will only need to borrow
for the second half of the year. The borrowed amount would be £11,429 [that is,
£12,000 ×100/(100 +5)]. If Project X were rejected by the business and Steady lent
her £10,000 to the bank for six months, it would grow to only £10,500 [that is,
£10,000 +(£10,000 ×^1 / 2 ×10%)].It seems clear that all three investors will have more to spend if Project X is under-
taken than if it is not, irrespective of when they wish to spend. This will also be true
for each of the business’s other shareholders. The shareholders will be unanimous that
Project X should go ahead.Project Y
Now let us suppose that Project X is not available but that the choice is either to pay
the dividend now or to undertake Project Y. This project also requires an immediate
cash investment of £100,000, but will produce only £109,000 next year when it will
cease.
Let us consider how accepting Project Y will affect Eager, who wants her money
now. Again she could borrow against next year’s dividend (£10,900); the amount that
she could borrow will be £9,909 [that is, £10,900 ×100/(100 +10)]. On the other hand,
if Project Y is rejected she would have £10,000 to spend. Clearly she would prefer rejec-
tion of the project. We could easily illustrate, using the same logic as that which we
applied to Project X, that Patient and Steady would agree with her, as indeed would