Question

The residual dividend policy approach to dividend policy is based on the theory that a firm's optimal dividend distribution policy is a function of the firm's 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 Red Bison Petroleum Producers Inc.: Red Bison Petroleum Producers Inc. has generated earnings of $180,000,000. Its target capital structure consists of 60% equity and 40% debt. It plans to spend $85,000,000 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. 60% 40% Debt Equity What will Red Bison Petroleum Producers's dividend payout ratio be if it follows a residual dividend policy? 71.67% 78.84% 53.75% 68.09% If Red Bison Petroleum Producers Inc, reduces the amount of its forecasted capital budget, how will this affect the firm's annual dividend, assuming that all other factors are held constant? The amount that Red Bison Petroleum Producers will pay out in dividends this year will increase. The amount that Red Bison Petroleum Producers will pay out in dividends this year will decrease.

Answer 1

Equity contribution in new project Income available for distribution Dividend payout ratio $ 51,000,000 =85000000*60% $ 129,000,000 =180000000-51000000 71.67% =129000000/180000000 Under residual dividend policy, debt ratio and dividend payout ratio will have direct relationship. If debt ratio increase, dividend payout ratio will increase and vice-versa Hence, "The amount that Red Bison Petroleum Producers will pay out in dividends this year will increase" Select "Should" Select 4th option

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