One position expressed in the financial literature is that firms set their divid
ID: 2776349 • Letter: O
Question
One position expressed in the financial literature is that firms set their dividends as a residual after using income to support new investments. A.Explain what a residual policy implies (assuming that all distributions are in the form of dividends), illustrating your answer with a table showing how different investment opportunities could lead to different dividend payout ratios. B, Think back to Chapter 13 where we considered the relationship between capital structure and the cost of capital. I f the WACC-versus-debt ratio plot was shaped like a sharp V, would this have a different implication for the importance of setting dividends according to the residual policy than if the plot was shaped like a shadow bowl (a flattened U)?
Explanation / Answer
Answer: The residual dividend policy is based primarily on the premise that, since new common stock is more costly than retained earnings, a firm should use all the retained earnings it can to satisfy its common equity requirement. Hence, the dividend payout under this policy is a function of the firm’s investment opportunities.
Net incom=$60
Target equity=60%
Particulars Poor Avearge Good Capital budget $40 $70 $150 Net income $60 $60 $60 Required equity (W* capital budget) $24 $42 $90 Distribution paid (NI-Required equity) $36 $18 -30 Distribution ratio (Dividend/NI) 60% 50% 0%Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.