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Using a Residual Dividend Policy

1. If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay

a. no dividends except out of past retained earnings.

b. no dividends to common stockholders.

c. dividends only out of funds raised by the sale of new common stock.

d. dividends only out of funds raised by borrowing money (i.e., issue debt).

e. dividends only out of funds raised by selling off fixed assets.

Discuss fully the reasons for your choice, then discuss briefly why the other choices are incorrect.

Solution Preview

The correct option is
b. no dividends to common stockholders.
A residual dividend policy implies that dividends would be paid if there are residual earnings after taking care of investment needs. In such a policy the dividend amount would fluctuate depending on the earnings and the investment needs. In some years the shareholders would get a high amount and in some years a low amount and so the ...

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The solution explains Residual Dividend policy

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