5. Is the Walter's model relevant to the dividend policy? Calculate the market price of the firm's
share as per Walter Model if dividend payout ratio is (i) 25%, (ii) 50% or (iii) 100% from the
following information:
Earnings per share
Rs. 10
Cost of equity
15%.
Rate of return on investment
10%.
What conclusion will you draw from these prices?
Answers
Answer:
Walter’s model on dividend policy believes in the relevance concept of a dividend. According to this concept, a dividend decision of the company affects its valuation. Walter’s theory further explains this concept in a mathematical model.
Table of Contents
1 Crux of Walter’s Model
2 Relation of Dividend Decision and Value of a Firm
3 Assumptions of Walter’s Model
3.1 Internal Financing
3.2 Constant IRR and Cost of Capital
3.3 Constant EPS and DPS
3.4 Infinite Life
3.5 Capital Market is perfect
3.6 No Flotation Cost, no transaction cost, no Corporate Dividend Tax
3.7 Only Equity Finance
4 Walter’s Model Valuation Formula and its Denotations
5 Implications of Walter’s Model
5.1 Growth Firm
5.2 Normal Firm
5.3 Declining Firm
6 Criticism of Walter’s Model
6.1 No External Financing
6.2 Constant r and k
6.3 Conclusion of retaining 100 % of earning
6.4 Other unrealistic assumptions
CRUX OF