If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay
A) no dividends to common stockholders.
B) dividends only out of funds raised by the sale of new common stock.
C) dividends only out of funds raised by borrowing money (i.e., issue debt).
D) dividends only out of funds raised by selling off fixed assets.
E) no dividends except out of past retained earnings.

Question

Quizplus · Accepted Answer

The residual dividend policy states that dividends are paid only from the residual (leftover) earnings after all the investments in positive net present value projects have been made. If the optimal capital budget requires the use of all earnings, then there will be no residual earnings left to pay out as dividends, so the firm should not pay any dividends to common stockholders.

If a Firm Adheres Strictly to the Residual Dividend Policy