The residual dividend model The residual distribution policy approach is based on the theory that a firm's optimal distribution policy is a function of the firm's target capital structure, the investment opportunities that the firm has, and the availability and cost of external capital. The firm makes distributions based on the residual earnings. Smith and Jones Co. is expected to generate $240 million in net income over the next year. Smith and Jones Co. has forecasted a capital budget of $88 million, 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 isits expected dividend payout ratio for this year? If Smith and Jones Co. reduces the amount of it: capital budget, how will this affect the firm's annual dividend, assuming that all other factors are held constant' The amount that Smith and Jones Co. will pay out in dividends this year will decrease. The amount that Smith and Jones Co. will pay out in dividends this year will increase. Most firms have earnings that vary considerably from year to year and do not grow at a reliably constant pace. Furthermore, their required investment may change often. Does this mean that the residual distribution policy approach can't be of any help to most firms? Yes No .Gaven Industries, which is in the same sector as Smith and Jones Co., has very stable, predictable earnings, but its capital investment tends to be lumpy. This means that its required capital spending is usually relatively low, but every few years, some sizable expenditures cause the firm's capital budget to be quite large. Should Gaven Industries be following a strict residual distribution policy? No Yes