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 avaliability and cost of external capital. The firm makes distributions based on the residual earnings. Consider the case of Yellow Duck Distribution Corporation: Yellow Duck Distribution Corporation is expected to generate $140,000,000 in net income over the next year. Yellow Duck Distribution's stockholders expect it to maintain its long-run dividend payout ratio of 20% 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 Yellow Duck Distribution increases its debt ratio, then its dividend payout ratio will , assuming that all other factors are held constant. What kind of company is most likely to follow a strict residual distribution policy? A firm whose investment needs change often What kind of company is most likely to follow a strict residual distribution policy? A firm whose investment needs change often A firm with stable, predictable earnings and investment A firm with highly variable earnings and investment A firm whose carnings are cyclical and follow the economy 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 bime? Dividends Ebrnings Cash flow