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 Purple Hedgehog Forestry Company: Purple Hedgehog Forestry Company is expected to generate $240,000,000 in net income over the next year. Purple Hedgehog Forestry has forecasted a capital budget of $85,000,000, and it wishes to maintain its current capital structure of 70% debt and 30% equity. If the company follows a strict residual distribution policy and makes distributions in the form of dividends, what is its expected dividend payout ratio for this year? 75.97% 89.38% 67.04% 80.44% If Purple Hedgehog Forestry increases its debt ratio, then its dividend payout ratio will constant. , assuming that all other factors are held What kind of company is most likely to follow a strict residual distribution policy? A firm with stable, predictable earnings and investment A firm whose earnings are cyclical and follow the economy A firm whose investment needs change often A firm with highly variable earnings and investment Gaven Industries, which is in the same sector as Purple Hedgehog Forestry, exhibits very stable and predictable earnings, but its capital investments tend to be lumpy. This means that Gaven's required capital investment spending is usually relatively low, but every few years, some sizable expenditures will cause the firm's capital budget to be quite large. Should Gaven Industries be following a strict residual distribution policy? Yes No