6. 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 Red Bison Petroleum Producers Inc.: 40% Equity 60% Debt Red Bison Petroleum Producers Inc. is expected to generate $200,000,000 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. 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 year's expected net income is 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? 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 decrease. O The amount that Red Bison Petroleum Producers will pay out in dividends this year will increase. What kind of company is most likely to follow a strict residual distribution policy? O A firm with highly variable earnings and investment O A firm whose earnings are cyclical and follow the economy O A firm with stable, predictable earnings and investment O A firm whose investment needs change often If you were to graph a firm's earnings, cash flows, and dividends over the past 20 years, which would you expect to be the most stable over time? O Earnings O Cash flow O Dividends