10. The dual dividend model Aa Aa The residual distribution policy approach to dividend poticy is based on the theory that a firm's optimal dvidend distribution policy is a function of the firm's target capital structure, the investment opportunities available to the firm, and the availability and cost of extemal capital. The firm makes distrbutions based on the resldual eamings Consider the case of Purple Hedgehog Forestry Corporation: Purple Hedgehog Forestry Corporation is expected to generate $140,000,000 in net income over the next year. Purple Hedgehog Forestry's stockholders expect it to maintain its long-run dvidend payout ratio of 25% of earnings. 40% Equity 60% Debt If the fi m wants to maintain its current capital structure of 60% debt and 40% equity, the maximum capital budget it can support with this years expected net income is If Purple Hedgehog Forestry increases its debt ratio, then its dividend payout ratio will all other factors are held constant assuming that Most firms have eamings that vary considerably from year to year and do not grow at a reliably constant pace. Furthermore, their required investment may change often. Does this mean that the residual dstribution policy approach cant be of any help to most firms? O yes No Gaven Industries, which is in the same sector as Purple Hedgeheg Forestry, exhibits very stabile and predictable earmings, but its capital investments tend to be tunpy. This mesns that Gavens required cepital investment spending is usubly relatively low, but every few years, some sizoble sxpenditures wil cause t to be ouite large. Should Gaven Industriss be folowing e strict residual distribution policy Yes