The residual distribution 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 Purple Hedgehog Forestry Inc.: Purple Hedgehog Forestry Inc. has generated earnings of $180,000,000. Its target capital structure consists of 60% equity and 40% debt. It plans to spend $83,000,000 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. What will Purple Hedgehog Forestry’s dividend payout ratio be if it follows a residual distribution policy? 79.56% 65.10% 72.33% 54.25% Purple Hedgehog Forestry is considering using more equity and less debt in its capital structure. Which of these statements best describes how this will affect the firm’s annual dividend, assuming that all other factors are held constant? Purple Hedgehog Forestry will pay a smaller annual dividend if it goes forward with this decision. Purple Hedgehog Forestry’s annual dividend will be greater if it goes forward with this decision. What kind of company is most likely to follow a strict residual distribution policy? A firm with stable, predictable earnings and investment All companies A firm whose investment needs change often A firm with highly variable earnings and investment If you were to graph a firm’s earnings, cash flows, and dividends over the past 20 years, which would you expect to be the most stable over time? Cash flow Earnings Dividends
The residual distribution 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 Purple Hedgehog Forestry Inc.: Purple Hedgehog Forestry Inc. has generated earnings of $180,000,000. Its target capital structure consists of 60% equity and 40% debt. It plans to spend $83,000,000 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. What will Purple Hedgehog Forestry’s dividend payout ratio be if it follows a residual distribution policy? 79.56% 65.10% 72.33% 54.25% Purple Hedgehog Forestry is considering using more equity and less debt in its capital structure. Which of these statements best describes how this will affect the firm’s annual dividend, assuming that all other factors are held constant? Purple Hedgehog Forestry will pay a smaller annual dividend if it goes forward with this decision. Purple Hedgehog Forestry’s annual dividend will be greater if it goes forward with this decision. What kind of company is most likely to follow a strict residual distribution policy? A firm with stable, predictable earnings and investment All companies A firm whose investment needs change often A firm with highly variable earnings and investment If you were to graph a firm’s earnings, cash flows, and dividends over the past 20 years, which would you expect to be the most stable over time? Cash flow Earnings Dividends
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Concept explainers
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question
The residual distribution 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 Purple Hedgehog Forestry Inc.:
Purple Hedgehog Forestry Inc. has generated earnings of $180,000,000. Its target capital structure consists of 60% equity and 40% debt. It plans to spend $83,000,000 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.
What will Purple Hedgehog Forestry’s dividend payout ratio be if it follows a residual distribution policy?
79.56%
65.10%
72.33%
54.25%
Purple Hedgehog Forestry is considering using more equity and less debt in its capital structure. Which of these statements best describes how this will affect the firm’s annual dividend, assuming that all other factors are held constant?
Purple Hedgehog Forestry will pay a smaller annual dividend if it goes forward with this decision.
Purple Hedgehog Forestry’s annual dividend will be greater if it goes forward with this decision.
What kind of company is most likely to follow a strict residual distribution policy?
A firm with stable, predictable earnings and investment
All companies
A firm whose investment needs change often
A firm with highly variable earnings and investment
If you were to graph a firm’s earnings, cash flows, and dividends over the past 20 years, which would you expect to be the most stable over time?
Cash flow
Earnings
Dividends
Expert Solution
Step 1
Out of the amount earned by the company during the year, the company distribute some of the profit as a dividend to their shareholders and retain the remaining amount in the retained earning account.
The company uses the amount from the retained earnings for the purpose of their growth i.e. for expansion of business.
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