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 Purple Hedgehog Forestry Group:

Purple Hedgehog Forestry Group is expected to generate $140,000,000 in net income over the next year. Purple Hedgehog Forestry Group has forecasted a capital budget of $85,000,000, and it wishes to maintain its current capital structure of 70% debt and 30% equity.

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

A.) 73.61% C.) 81.79%

B.) 65.43% D.) 69.52%

If Purple Hedgehog Forestry Group increases its debt ratio, then its dividend payout ratio will_________, assuming that all other factors are held constant.

A.) Increase B.) Decrease

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?

A.) The firms dividends B.) The firms earnings

Spandelay Industries Inc. is a typical company that is very concerned with meeting investors expectations and keeping investors happy. Its earnings tend to fluctuate from year to year because of the nature of the business the company is in. Which of these statements most likely describes Spandelay Industries Inc.s dividend policy?

A.) Spandelay Industries Inc. most likely pays very large dividends in years with high earnings and small dividends in the years with low earnings.

B.) Despite the fact that Spandelay Industries Inc.s earnings tend to fluctuate from year to year, the company most likely pays a predictable, stable dividend each year.