Question

According to the residual theory of​ dividends, if a​ 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 less dividends D. pay no cash dividends

Answer 1

Answer:

Option D Pay no cash dividends

Explanation:

The residual theory of dividends (as its name suggests) says that the dividend must be paid out of the amount that the firm doesn't desire to retain because it can finance its investments from the retained earnings. So if the investment funding requires excessive of its retained earnings then it will not pay dividends. So in the given scenario, the need of finance for the firm is more than the fund that the company has retained.

So according to residual theory of dividends, the company must not issue cash dividends because it already requires funds.