a. The residual distribution policy is based 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. Thus, the distribution under this policy is a function of the firm's investment opportunities.

b. Yes. A more shallow plot implies that changes from the optimal capital structure have little effect on the firm's cost of capital, hence value. In this situation, dividend policy is less critical than if the plot were V-shaped.