Certified Financial Management Specialist Practice Exam

Which of the following defines the residual dividend policy?

1. Paying consistent dividends regardless of earnings

2. Distributing dividends only after all profitable projects have been funded

3. Setting dividends based on equity financing

4. Offering dividends based on shareholder preference

The correct answer is: Distributing dividends only after all profitable projects have been funded

The residual dividend policy is defined as distributing dividends only after all profitable projects have been funded. This approach emphasizes that a company will allocate its earnings first to capital expenditures that yield the highest returns, which is aligned with maximizing shareholder value. Only after ensuring that all profitable investment opportunities have been financed does the company consider paying out dividends to shareholders. This strategy is based on the principle that dividends should not be paid at the expense of growth and investment, as reinvesting capital in profitable ventures can create more significant value for shareholders in the long run. Therefore, under this policy, dividends are considered a residual payment that is made only when there are leftover earnings after all investment opportunities have been funded. In contrast, other options suggest policies that don't prioritize the funding of profitable projects, leading to a less strategic approach to managing company earnings and investments.