The residual distribution policy approach to dividend policy is based on the theory that a firms optimal dividend distribution policy is a function of the firms 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 $86,000,000, 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?

61.18%

69.33%

73.41%

81.57%

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 firms annual dividend, assuming that all other factors are held constant?

Red Bison Petroleum Producerss 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.

Most firms have earnings that vary considerably from year to year and do not grow at a reliably constant pace. Furthermore, their required investment may change often. Does this mean that the residual distribution policy approach cant be of any help to most firms?

Yes

No

Gaven Industries, which is in the same sector as Red Bison Petroleum Producers, exhibits very stable and predictable earnings, but its capital investments tend to be lumpy. This means that Gavens required capital investment spending is usually relatively low, but every few years, some sizable expenditures will cause the firms capital budget to be quite large. Should Gaven Industries be following a strict residual distribution policy?

Yes

No