Financial Management and Business Data Analytics · Dividend Decisions and Dividend Theories

Walter's Model of Dividend Policy: Formula and Numericals

Q: What is Walter's model in simple words?

It is a dividend theory that says the payout you choose changes the share price. The effect depends on whether the firm earns more (r) or less than shareholders' required return (Ke) on retained money.

Q: What is the optimum payout ratio for a growth firm under Walter's model?

A growth firm has r greater than Ke. Its optimum payout ratio is zero, because retaining all earnings gives the highest share price.

Q: What happens when r equals Ke in Walter's model?

The firm is a normal firm. The share price is the same at every payout ratio, so there is no optimum payout and dividend policy is irrelevant in that case.

Q: What are the main limitations of Walter's model?

It assumes no external financing, constant r and Ke, and constant earnings and dividends. In practice r falls as a firm invests more and Ke changes with risk, so the model is a simplification.

Updated 10 October 2026 · Fact-checked

Walter's model says dividend policy affects share value. Price P = [D + (r ÷ Ke) × (E − D)] ÷ Ke. If r > Ke, retain all earnings (payout 0%). If r < Ke, pay out 100%. If r = Ke, payout does not matter. Substitute the figures and compare.

Understand Walter's Model

Walter's model is a relevance theory. It says the dividend you pay changes the market price of the share. This is different from the Modigliani-Miller view, where dividends do not matter.

The idea is simple. A firm can either pay earnings out as dividends or retain them and reinvest. Retained earnings are worth more to shareholders only if the firm earns more on them than shareholders could earn elsewhere. The firm's return is r (return on investment). The shareholders' alternative return is Ke (cost of equity or cost of capital).

So the model compares r with Ke. A growth firm has r > Ke. Here retention creates value, so the optimum payout is zero. A normal firm has r = Ke. Retention and payout give the same price, so there is no optimum payout. A declining firm has r < Ke. Shareholders can earn more elsewhere, so the optimum payout is 100%.

The price is the present value of two parts: the dividend stream, and the extra earnings from reinvested profits. That is why the formula has a dividend term D and a retention term (E − D).

The assumptions matter for theory questions:

Financing is only by retained earnings. No new debt or equity is raised.
r and Ke stay constant.
Earnings (E) and dividend (D) stay constant forever. Firm has an infinite life.
All earnings are either distributed or reinvested immediately.
Per-share figures are used throughout (EPS, DPS).

Key rules to remember

Walter's share price: P = [D + (r ÷ Ke) × (E − D)] ÷ Ke; P = market price per share, D = DPS, E = EPS, r = return on investment, Ke = cost of equity. Use r and Ke as decimals.
Equivalent form with payout: P = [D + (r ÷ Ke) × (E − D)] ÷ Ke, where D = D/P ratio × E; Payout ratio = D ÷ E. Retention ratio = 1 − payout ratio. Use this to find D from a given payout ratio.
Decision rule: growth firm: r > Ke ⇒ optimum payout = 0%; Price falls as payout rises. Retain everything.
Decision rule: normal firm: r = Ke ⇒ price unchanged at any payout; Price equals E ÷ Ke. No optimum payout.
Decision rule: declining firm: r < Ke ⇒ optimum payout = 100%; Price rises with payout. Distribute all earnings.

How to solve Walter's Model questions

Use this order for any Walter's model question, whether it asks for price, optimum payout or a comparison of policies.

1Write down E (EPS), D (DPS), r and Ke. Convert percentages to decimals. If payout ratio is given, compute D = payout × E.
2Compare r with Ke to classify the firm as growth, normal or declining.
3State the optimum payout from the classification: 0%, indifferent, or 100%.
4Substitute into P = [D + (r ÷ Ke) × (E − D)] ÷ Ke. Compute r ÷ Ke first, then E − D.
5Repeat for each payout level the question gives, in a small table of D, E − D and P.
6Compare prices and state which policy gives the highest price.
7Write a one-line conclusion linking the result to r versus Ke.

Quickest way: Compare r and Ke first, then compute only what is asked

When to use it: Use when the exam asks for the optimum payout or the best policy among a few options and time is short.

Compare r and Ke. This alone gives the optimum payout, so you can answer that part in seconds.
For price, compute r ÷ Ke once and reuse it.
Note that each extra ₹1 of dividend changes price by (1 − r ÷ Ke) ÷ Ke. If r > Ke this is negative, so lower D gives a higher price.
Compute only the two extreme cases (0% and 100%) to confirm the direction.
Check MCQ options by rough estimate: if r = Ke, price equals E ÷ Ke.

Common mistakes in Walter's Model

Using the wrong sign comparison and recommending dividends for a growth firm.
Students remember that dividends are good for shareholders and forget that retention earns r.
Fix: Say it aloud: r > Ke means retain. r < Ke means distribute. r = Ke means indifferent.
Putting E instead of (E − D) in the retention term.
The formula looks like it needs total earnings, so the deduction of D is forgotten.
Fix: Only retained earnings are reinvested. Always write E − D as a separate line before substituting.
Entering r and Ke as whole numbers in one place and decimals in another.
Rushing through percentages such as 15% and 10%.
Fix: Convert both to decimals first. Note that r ÷ Ke is a ratio and is the same either way, but the final division by Ke is not.
Computing D wrongly when payout ratio is given.
Students use the payout percentage as the DPS itself.
Fix: D = payout ratio × EPS. A 40% payout on EPS of ₹10 gives D = ₹4.
Forgetting the assumptions or listing 'no taxes' only.
Students learn the formula but not the conditions behind it.
Fix: Learn the key five: only internal financing, constant r and Ke, constant E and D, infinite life, and immediate reinvestment or distribution.
Saying the model has an optimum payout for a firm with r = Ke.
Students assume every case has a single best answer.
Fix: When r = Ke the price is the same at all payouts, so state that there is no optimum payout.

Worked examples

Example 1

A company has EPS of ₹10, return on investment r = 15% and cost of equity Ke = 10%. Using Walter's model, find the market price per share if the payout ratio is (a) 0%, (b) 40% and (c) 100%. State the optimum payout.

Show the solution

r = 0.15, Ke = 0.10, so r ÷ Ke = 1.5. Since r > Ke, this is a growth firm and the optimum payout is 0%.
(a) D = 0, E − D = 10. P = [0 + 1.5 × 10] ÷ 0.10 = 15 ÷ 0.10 = ₹150.
(b) D = 0.40 × 10 = 4, E − D = 6. P = [4 + 1.5 × 6] ÷ 0.10 = [4 + 9] ÷ 0.10 = 13 ÷ 0.10 = ₹130.
(c) D = 10, E − D = 0. P = [10 + 0] ÷ 0.10 = ₹100.
Price falls as payout rises: ₹150, ₹130, ₹100.

Answer: P = ₹150 at 0% payout, ₹130 at 40% payout and ₹100 at 100% payout. Because r (15%) exceeds Ke (10%), the optimum payout is 0%.

Example 2

Kaveri Textiles Ltd has EPS of ₹8 and Ke = 12%. Its return on investment is 9%. Using Walter's model, compute the price per share at a dividend of ₹2 and at a dividend of ₹8, and state the optimum payout.

Show the solution

r = 0.09, Ke = 0.12, so r ÷ Ke = 0.75. Since r < Ke, this is a declining firm and the optimum payout is 100%.
At D = 2: E − D = 6. P = [2 + 0.75 × 6] ÷ 0.12 = [2 + 4.5] ÷ 0.12 = 6.5 ÷ 0.12 = ₹54.17 (approx).
At D = 8: E − D = 0. P = 8 ÷ 0.12 = ₹66.67 (approx).
The price is higher at full payout, which agrees with the rule for r < Ke.

Answer: Price is about ₹54.17 at D = ₹2 and about ₹66.67 at D = ₹8. As r (9%) is below Ke (12%), the optimum payout is 100%.

Exam tips

Always open with the r versus Ke comparison. It earns marks even if arithmetic slips later.
Show the formula, then the substituted values, then the answer. Step marks depend on this layout.
For theory questions, list assumptions as short bullets and add one line on criticism: the model ignores external financing and assumes constant r and Ke, which is unrealistic.
In MCQs, compute r ÷ Ke first. Many options can be eliminated by direction alone: growth firm, price falls as D rises.
Round only at the final step and give the answer in rupees per share.

Practice questions from Dividend Decisions and Dividend Theories

Walter's Model in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CS ExecutiveWalter's Model

Walter's Model: frequently asked questions

What is Walter's model in simple words?

It is a dividend theory that says the payout you choose changes the share price. The effect depends on whether the firm earns more (r) or less than shareholders' required return (Ke) on retained money.

What is the optimum payout ratio for a growth firm under Walter's model?

A growth firm has r greater than Ke. Its optimum payout ratio is zero, because retaining all earnings gives the highest share price.

What happens when r equals Ke in Walter's model?

The firm is a normal firm. The share price is the same at every payout ratio, so there is no optimum payout and dividend policy is irrelevant in that case.

What are the main limitations of Walter's model?

It assumes no external financing, constant r and Ke, and constant earnings and dividends. In practice r falls as a firm invests more and Ke changes with risk, so the model is a simplification.