Residual dividend policy
Under a residual dividend policy, a firm funds all positive-NPV projects first from earnings, at its target equity ratio, and pays out only what is left over as the dividend.
What it is
See it move
Under a residual dividend policy, the dividend is whatever is left after funding every positive-NPV project. A firm earning €10,000,000 in net income, with €12,000,000 of projects to fund at a 60 percent target equity ratio, sets aside €7,200,000 in equity financing first, leaving a residual dividend of €2,800,000.
The formula
Variables
- Dividend (€)
- Net income (€)
- Target equity ratio (%)
- Planned capital budget (€)
Gives the residual dividend once the equity-funded share of the planned capital budget has been set aside from net income.
Check yourself
A company follows a residual dividend policy. It reports net income of €18,000,000, has a target capital structure of 70% equity and 30% debt, and has identified €20,000,000 of positive-NPV projects to fund this year. What dividend does the residual policy imply?