5. The residual dividend model The residual distribution 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 Purple Hedgehog Forestry Group: Purple Hedgehog Forestry Group is expected to generate $200,000,000 in net income over the next year. Purple Hedgehog Forestry's stockholders expect it to maintain its long-run dividend payout ratio of 30% of earnings. If the firm wants to maintain its current capital structure of 60% debt and 40% equity, the maximum capital budgethc can support with this year's expected net income is If Purple Hedgehog fore te ratio, then its dividend payout ratio will , assuming that all other factors are held constant. Most firms have eaming bly from year to year and do not grow at a rellably constant pace. Furthermore, their tequired investment may change otten, Doe esidual distribution policy approach can't be of any help to most firms