Residual Dividend Policy and Stable Dividend Conditions

Conditions for Stable Dividend Policy

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Question

Which of the following conditions must be satisfied for a stable dividend policy to result from the Residual Dividend Policy?

I. The earnings of a firm must be stable.

II. Investor preference for dividends must be stable.

III. The investment opportunities available to the firm must be stable.

IV. There should be no signaling effects involved.

Answers

Explanations

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A. B. C. D. E. F. G.

Explanation

Under the Residual Dividend Policy, a firm first determines the amount of capital it requires for sufficiently profitable projects. It then uses retained earnings to supply equity capital and raises debt in the proper amount to maintain the target capital structure. If any earnings are left over after this, they are paid out as dividends. If not, the firm will not only not pay any dividends but also issues new equity for financing. Thus, for this to lead to stable dividends, one must have stability in earnings and available investment opportunities. Note that for positive dividends, earnings must exceed capital requirements under the Residual

Dividend Policy.

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