If a firm adopts a residual distribution policy, distributions are determined as a residual item. Therefore, the better the firm's investment opportunities, the lower its distributions should be.

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Quizplus · Accepted Answer

This is true because under a residual distribution policy, the firm first invests in all available projects that meet its minimum acceptable rate of return. If there are still funds left over after investing in all profitable projects, those funds are then distributed to shareholders as dividends. Therefore, if the firm has better investment opportunities, then more funds will be invested in those projects, leaving less for distributions to shareholders.

If a Firm Adopts a Residual Distribution Policy, Distributions Are