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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

One position expressed in the financial literature is that firms set their dividends as a residual after using income to support new investment.

  1. a. Explain what a residual dividend policy implies, illustrating your answer with a table showing how different investment opportunities can lead to different dividend payout ratios.
  2. b. Think back to Chapter 14 where we considered the relationship between capital structure and the cost of capital. lf the WACC-versus-debt-ratio plot was shaped like a sharp V, would this have a different implication for the importance of setting dividends according to the residual policy than if the plot was shaped like a shallow bowl (a flattened U)?

a.

Summary Introduction

To explain: Residual dividend policy and the effect of different investment opportunities on different dividend payout ratio.

Introduction:

Dividend Policy:

It is the rules and regulations or protocol, which a company sets to share its earning with its shareholders. Dividend’s payment include payment to be made legally as well as financially.

Explanation
  • The residual dividend policy is a premise based and new common stock costs more than the retained earnings so a firm must use all its retained earnings to fulfill the common stock need.
  • If the profitable investment opportunities are large in number for a firm i...

b.

Summary Introduction

To explain: WACC versus debt ratio implications for the significance of setting dividends as per the residual policy if the plot was shaped like a shallow bowl than V.

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