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SUBMITTED TO

ASHISH PANDEY SIR

MBA DEPARTMENT ,SRGI

SUBMITTED BY:

Deepika Shrivastava

MBA2 semester

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Professor James E Walter argues that the choice of

dividend may affect the value of the firm.Themodel shows the relationship between the firmsrate of return, r,and its cost of capital , k, indetermining the dividend policy that will

maximize the wealth of shareholders.

Walters model is based on the followingassumptions;

Internal Financing: the firm finance or raisescapital by retained earnings or plough back ofprofits,not by issuing shares or debentures.

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Constant return and cost of capital:The firmss rate of

return ,r and its cost of capital,k are constant. 100% payout or retention:All earnings are either

distributed as dividends or reinvested internallyimmediately.

Constant EPS and DIV:The values of EPS and DIV mayme changed in the model to determine the results,butany given values of EPS and DIV are assumed constant.

Infinite time:The firm has a very long or infinite life.

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Walters formula to determine the market price per

share is as follows:P=DIV/K + r(EPS-DIV)/k/k

Where

P=market price per share

DIV=dividend per share

EPS=earnings per share

R= firms rate of return

K=firms cost of capital.

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Irms is zero.

GROWTH FIRM:Internal rate more than oppurtunitycost of capital(r>k)

High yeiding returns than oppurtunity cost of capitalThe optimum payout ratio for growth firms is zero.

NORMAL FIRMS: Intenal rate is equal to oppourtunitycost of capital.(r=k)

Dividend policy will not affect the market value of sharesas the shareholders will get the same return from thefirm as expected out of them.for such firms there is nooptimum dividend payout and the value of the firmwoul d not change with the change in dividend rate.

DECLINING FIRMS:(r

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The shareholders would stand to gain if the firm distributesits earnings.For such firms the optimum payout would be

100% and the firm should distribute its entire earnings asdividends.

CRITISISM Of WALTERS MODEL

1.The basic assumptions that investments are financedthrough retained earnings onlyis rarely true in the realcorporate world.

2.The internal rate of rate also does not remains constant ie.r.With increased investment the rate of return also

changes.for ex if the firm has invested 1000o rs at 10%sowiilget in return 1000 and if invested 20000 at same% but

will get 2000 so rate of retun changes and not remainsconstant.

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3.The assumption that cost of capital ie.k will remain

constant also does not hold good.As a firms riskpattern does not remain constant ,it is not proper toassume k always constant.