neutral investments (zero net present value investments),
earningafairrateofreturn,giventheriskoftheinvestments.
Thus,acashbalanceof$2billioninvestedinTreasurybills
andcommercialpapermayearnalowrateofreturnbutthat
return is what you would expect to earn on these investments.
Chapter 10 outlinedtwoscenarioswherealargecashbalance
maynotbevalueneutralandmaythusprovideopportunities
forvalueenhancement.Thefirstiswhencashisinvestedat
below-marketrates.Afirmwith$2billioninacashbalance
held in a non-interest-bearing checking account is clearly
hurtingits stockholders. Thesecond is when investors are
concernedthatthecashwillbemisusedbymanagementto
makepoorinvestments (oracquisitions).Inthis case,there
willbeadiscountappliedtocashtoreflectthelikelihoodthat
management willmisusethecash andtheconsequences of
suchmisuse.Revertingbacktotheexampleofthecompany
with $2 billion in cash, assume that investors believe that
thereisa 25 percentchancethatthiscashwillbeusedtofund
anacquisitionandthatthefirmwilloverpayby$500million
onthisacquisition.Thevalueofcashatthiscompanycanbe
estimated as follows:
Ineitherofthesescenarios,returningsomeorallofthiscash
tostockholdersintheformofdividendsorstockbuybacks
will make stockholders better off.
Holdings in Other Companies