ACCA Advanced Financial Management (AFM) Practice Exam

What is a primary advantage of the residual payout policy?

1. It increases stock price volatility

2. It minimizes new stock issues and flotation costs

3. It guarantees stable dividends

4. It appeals to all forms of investor clientele

The correct answer is: It minimizes new stock issues and flotation costs

The residual payout policy is a dividend policy that dictates that dividends should be paid out of the remaining earnings after all profitable investment opportunities have been funded. This approach offers the primary advantage of minimizing new stock issues and flotation costs. By adopting this policy, a company prioritizes its internal investment opportunities, thereby using retained earnings to finance these investments before considering dividends. This means that the company will not have to issue new equity, which incurs floatation costs (the costs associated with issuing new securities, including legal, underwriting, and registration fees). By avoiding these costs, the company can enhance the overall value for existing shareholders by efficiently utilizing retained earnings. This policy is particularly beneficial during periods when the company has profitable projects to invest in, as it ensures that funds are allocated efficiently while still providing dividends from excess earnings. As a result, it supports healthy financial management without creating unnecessary liabilities through new stock issuance.