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 Corporation:

Purple Hedgehog Forestry Corporation is expected to generate $$180,000,000$ in net income over the next year. Purple Hedgehog

Forestry has forecasted a capital budget of $$86,000,000,$ 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?

$85\mathrm{.}67\%$

$89\mathrm{.}95\%$

$81\mathrm{.}39\%$

$59\mathrm{.}97\%$

If Purple Hedgehog Forestry 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?

decrease

increase

A firm with highly variable earnings and investment

A firm with stable, predictable earnings and investment

A firm whose investment needs change often

All companies

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