5. The residual dividend model Aa Aa The residual dividend policy approach to dividend policy is based on the theory that a firm's optimal dividend 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 external capital. The firm makes distributions based on the residual earnings. Consider the case of Red Bison Petroleum Producers Inc.: Red Bison Petroleum Producers Inc. is expected to generate $240,000,000 in net income over the next year. Red Bison Petroleum Producers's stockholders expect it to maintain its long-run dividend payout ratio of 40% of earnings. 40% Equity 60% Debt If the firm 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 sY If Red Bison Petroleum Producers Inc. reduces the amount of its forecasted capital budget, how will this affect the firm's annual dividend, assuming that all other factors are held constant? O The amount that Red Bison Petroleum Producers will pay out in dividends this year will increase. O The amount that Red Bison Petroleum Producers will pay out in dividends this year will decrease. If you were to graph a firm's earnings and dividends over the past 20 years, which would you expect to be the most stable over time? O The firm's earnings O The firm's dividends What kind of company is most likely to follow a strict residual dividend policy? O A firm with stable, predictable earnings and investment A firm with highly variable earnings and investment O A firm whose investment needs change often O A firm whose earnings are cyclical and follow the economy