Aa Aa 4. The residual dividend model The residual dividend policy approach to dividend policy is based on the theory that a firm's optimal dividencd 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 Corporation: e Hedgehog Forestry Corporation 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 25% of earnings. 40% Equity Purpl 60% Debt If the firm wants to maintain its current capital structure of 60% debt and 40% equity, the maxim u n capital budget it can support with this year's expected net income is [ If Purple Hedgehog Forestry increases its debt ratio, then its dividend payout ratio will all other factors are held constant , assuming that Green Parrot Cruise Inc. has very stable, predictable earnings, but its capital investment tends to be lumpy. That means that its required capital budget usually is relatively low, but every few years some large expenditures cause the firm's capital budget to be quite large. Green Parrot Cruise follow a strict residual dividend policy. Fosh Play WIN 0109