According to the residual theory of dividends, if the firm's equity need exceeds the amount of retained earnings, the firm would
A) borrow to pay the cash dividend.
B) sell additional stock to pay the cash dividend.
C) pay no cash dividends.
D) not need to consider its dividend policy.

Question

Quizplus · Accepted Answer

The residual theory of dividends states that a firm should only pay dividends from its residual earnings or what remains after it has met all of its equity needs such as capital expenditures, debt repayments, and working capital requirements. If the equity needs exceed the retained earnings, then there are no residual earnings left to pay dividends. In such a case, the firm should not pay any cash dividends and retain the earnings for future use or investment in the business. Borrowing or selling additional stock to pay dividends would increase the firm's financial risk and dilute the existing shareholders' ownership, respectively. Not considering the dividend policy is not a viable option for a firm that wants to maximize shareholder value or attract potential investors.

According to the Residual Theory of Dividends, If the Firm's