The residual distribution policy approach is based on the theory that a firm's optimal distribution policy is a function of the firm's target capital structure, the investment opportunities that the firm has, and the availability and cost of external capital. The firm makes distributions based on the residual earnings. Consider the following example: ABC Telecom Inc. is expected to generate $240 million in neti income over the next year. ABC Telecom Inc.'s shareholders expect it to maintain its long-run dividend payout ratio of 40% of earnings. If the firm wants to maintain its current capital structure of 60% debt and 40% equity, what is the maximum capital budget it can support with this year's expected net income? Yes Most firms have earnings that vary considerably from year to year and do not grow at a reliably constant pace. Furthermore, their required investment may change often. Does this mean that the residual distribution policy approach can't be of any help to most firms? No 60% Debt Cash flow 40% Equity If you were to s ph a firm's earnings, cash flows, and dividends over the past 20 years, which would you expect to be the most stable over time? Dividends Earnings
The residual distribution policy approach is based on the theory that a firm's optimal distribution policy is a function of the firm's target capital structure, the investment opportunities that the firm has, and the availability and cost of external capital. The firm makes distributions based on the residual earnings. Consider the following example: ABC Telecom Inc. is expected to generate $240 million in neti income over the next year. ABC Telecom Inc.'s shareholders expect it to maintain its long-run dividend payout ratio of 40% of earnings. If the firm wants to maintain its current capital structure of 60% debt and 40% equity, what is the maximum capital budget it can support with this year's expected net income? Yes Most firms have earnings that vary considerably from year to year and do not grow at a reliably constant pace. Furthermore, their required investment may change often. Does this mean that the residual distribution policy approach can't be of any help to most firms? No 60% Debt Cash flow 40% Equity If you were to s ph a firm's earnings, cash flows, and dividends over the past 20 years, which would you expect to be the most stable over time? Dividends Earnings
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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Transcribed Image Text:The residual distribution policy approach is based on the theory that a firm's optimal distribution policy is a function of the firm's target capital
structure, the investment opportunities that the firm has, and the availability and cost of external capital. The firm makes distributions based on the .
residual earnings.
Consider the following example:
ABC Telecom Inc. is expected to generate $240 million in neti
income over the next year. ABC Telecom Inc.'s shareholders
expect it to maintain its long-run dividend payout ratio of
40% of earnings.
If the firm wants to maintain its current capital structure of 60% debt and 40% equity, what is the maximum capital budget it can support with this
year's expected net income?
Yes
60%
Debt
Most firms have earnings that vary considerably from year to year and do not grow at a reliably constant pace. Furthermore, their required investment
may change often. Does this mean that the residual distribution policy approach can't be of any help to most firms?
No
40%
Equity
O Dividends
Earnings
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
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