The residual distribution policy approach to dividend policy is based on the theory that a firm$$s optimal dividend distribution policy is a function of the firm$$s target capital structure, the investment opportunities available to the firm, and the availability and cost of external capital. The firm makes distributions based on the residual earnings.

Consider the case of Red Bison Petroleum Producers Group:

Red Bison Petroleum Producers Group is expected to generate $$140,000,000$ in net income over the next year. Red Bison Petroleum Producers has forecasted a capital budget of $$88,000,000,$ and it wishes to maintain its current capital structure of $70\%$ debt and $30\%$ equity.

If the company follows a strict residual distribution policy and makes distributions in the form of dividends, what is its expected dividend payout ratio for this year?

$81\mathrm{.}14\%$

$77\mathrm{.}08\%$

$64\mathrm{.}91\%$

$89\mathrm{.}25\%$

Red Bison Petroleum Producers is considering using more equity and less debt in its capital structure. Which of these statements best describes how this will affect the firm$$s annual dividend, assuming that all other factors are held constant?

Red Bison Petroleum Producers$$s annual dividend will be greater if it goes forward with this decision.

Red Bison Petroleum Producers will pay a smaller annual dividend if it goes forward with this decision.

What kind of company is most likely to follow a strict residual distribution policy?

A firm whose earnings are cyclical and follow the economy

A firm whose investment needs change often

A firm with stable, predictable earnings and investment

A firm with highly variable earnings and investment

If you were to graph a firm$$s earnings, cash flows, and dividends over the past $20$ years, which would you expect to be the most stable over time?

Cash flow

Earnings

Dividends