The residual dividend 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 Yellow Duck Distribution Company:

Yellow Duck Distribution Company has generated earnings of $140,000,000. Its target capital structure consists of 60% equity and 40% debt. It plans to spend $83,000,000 on capital projects over the next year and expects to finance this investment in the same proportion as its capital structure. The company makes distributions in the form of dividends.

What will Yellow Duck Distribution Companys dividend payout ratio be if it follows a residual dividend policy?

48.32%

54.77%

51.54%

64.43%

If Yellow Duck Distribution Company increases its debt ratio, then its dividend payout ratio will , assuming that all other factors are held constant.

If you were to graph a firms earnings and dividends over the past 20 years, which would you expect to be the most stable over time?

-The firms earnings

-The firms dividends