If a firm adopts a residual distribution policy, distributions are determined as a residual after funding the capital budget.Therefore, the better the firm's investment opportunities, the lower its payout ratio should be.

Question

Quizplus · Accepted Answer

In a residual distribution policy, the firm funds its capital budget first, and then distributes the remaining earnings as dividends. Therefore, if the firm has more profitable investment opportunities, it will allocate more funds towards the capital budget and pay out a smaller proportion of its earnings as dividends, resulting in a lower payout ratio.

If a Firm Adopts a Residual Distribution Policy, Distributions Are