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Corporate Accounting and Financial Management · Dividend Decisions

Walter's Model of Dividend Policy: Formula and Numericals

Updated 11 October 2026 · Fact-checked

Walter's model says a firm's share price depends on dividends and retained earnings, and that the best payout depends on r versus k. P = [D + (r ÷ k)(E − D)] ÷ k. If r > k, pay no dividend. If r < k, pay out fully. If r = k, payout does not matter.

Understand Walter's Model

Walter's model is a theory of dividend policy. It claims that dividend policy affects the value of a share. This is different from the Modigliani-Miller view, where dividend policy is irrelevant.

The model compares two rates. r is the return the firm earns on the money it reinvests. k is the cost of capital, which is the return shareholders expect. The comparison tells you whether the firm or the shareholder can use the money better.

If r > k, the firm is a growth firm. Every rupee retained earns more than shareholders could earn elsewhere. So the firm should retain profits, and the optimal payout is 0%. If r < k, the firm is a declining firm. Shareholders can earn more outside, so the optimal payout is 100%. If r = k, the firm is a normal firm. The share price is the same at any payout, so there is no optimal ratio.

The price is the sum of two parts. The first is the present value of the dividends. The second is the present value of the extra earnings from retained profits. That is why the formula has D in one place and (E − D) in another.

Assumptions:
- Financing is only by retained earnings. No new debt or equity is issued.
- r and k are constant.
- The firm has an infinite life.
- EPS (E) and DPS (D) stay constant for ever.
- All earnings are either paid out or reinvested at once.

Limitations: Financing only from retained earnings is unrealistic. A constant r ignores that returns fall as investment rises. A constant k ignores that risk changes with the payout. So the model is useful for understanding, but it is weak in practice.

Key rules to remember

Walter's share price
P = [D + (r ÷ k) × (E − D)] ÷ k
P = market price per share, D = dividend per share, E = earnings per share, r = return on investment, k = cost of capital (as decimals).
Equivalent form using payout
P = [D + (r ÷ k) × (E − D)] ÷ k, where D = E × payout ratio
Use when the payout ratio is given instead of D.
Retention
Retained earnings per share = E − D
This is the amount that is reinvested at rate r.
Optimal payout rule
r > k: payout 0% | r < k: payout 100% | r = k: any payout
Growth firm, declining firm and normal firm respectively.

How to solve Walter's Model questions

Follow the same order for any Walter's model question. It keeps the working clean and shows the examiner your logic.

  1. 1List the data: E, D (or payout ratio), r and k. Convert percentages to decimals.
  2. 2If only the payout ratio is given, find D = E × payout ratio.
  3. 3Find retained earnings per share: E − D.
  4. 4Compute r ÷ k and multiply it by (E − D).
  5. 5Add D to this figure, then divide the total by k to get P.
  6. 6Repeat for each payout ratio if the question asks for several.
  7. 7Compare r with k and state the type of firm and the optimal payout.
  8. 8Write a one-line conclusion that answers exactly what was asked.

Quickest way: Decide first, calculate second

When to use it: Use this when the question asks for the optimal payout or asks you to compare payout ratios.

  1. Compare r and k first. This tells you the best policy before any arithmetic.
  2. If r > k, the price rises as D falls. The lowest payout gives the highest price.
  3. If r < k, the price rises as D rises. The highest payout gives the highest price.
  4. If r = k, P = E ÷ k at any payout, so calculate once.
  5. Calculate only the prices the question requires, and keep r ÷ k as a fixed ratio to save time.

Common mistakes in Walter's Model

  • Using r and k as whole numbers such as 15 and 10 in the formula.

    The percentages are copied directly from the question.

    Fix: Convert to decimals (0.15, 0.10) before dividing by k. Otherwise the final price is wrong by a factor of 100.

  • Using E instead of (E − D) for the retained part.

    Students forget that only the retained portion earns r.

    Fix: Always write E − D on its own line first, then multiply by r ÷ k.

  • Dividing only the bracket by k in part and not the full numerator.

    The nested formula looks like two separate terms.

    Fix: Add D and (r ÷ k)(E − D) first, then divide the whole total by k.

  • Giving the wrong optimal payout.

    Students mix up growth and declining firms.

    Fix: Remember: higher r than k means keep the money (0% payout). Lower r than k means give it out (100% payout).

  • Forgetting to convert the payout ratio into D.

    The question gives a percentage of earnings, not rupees per share.

    Fix: Calculate D = E × payout ratio before using the formula.

  • Listing assumptions or limitations with no link to the model.

    Students memorise a list without understanding it.

    Fix: Explain each point in one line, for example: no external financing means all new investment comes from retained earnings.

Worked examples

Example 1

Sharma Textiles Ltd has EPS of ₹10, r = 15% and k = 10%. Using Walter's model, find the share price if the dividend payout ratio is (a) 0% and (b) 50%. State the optimal payout.

Show the solution
  1. Data: E = ₹10, r = 0.15, k = 0.10. So r ÷ k = 1.5.
  2. (a) Payout 0%: D = ₹0. E − D = ₹10.
  3. P = [0 + 1.5 × 10] ÷ 0.10 = 15 ÷ 0.10 = ₹150.
  4. (b) Payout 50%: D = ₹5. E − D = ₹5.
  5. P = [5 + 1.5 × 5] ÷ 0.10 = (5 + 7.5) ÷ 0.10 = 12.5 ÷ 0.10 = ₹125.
  6. Since r (15%) > k (10%), the firm is a growth firm. The price is higher at a lower payout.

Answer: Price is ₹150 at 0% payout and ₹125 at 50% payout. The optimal payout ratio is 0%, because r > k.

Example 2

Iyer Pharma Ltd has EPS of ₹8 and k = 12%. It pays a dividend of ₹4 per share. Using Walter's model, find the share price if r is (a) 8% and (b) 12%. What is the optimal payout in each case?

Show the solution
  1. Data: E = ₹8, D = ₹4, E − D = ₹4, k = 0.12.
  2. (a) r = 0.08. r ÷ k = 0.08 ÷ 0.12 = 0.6667.
  3. P = [4 + 0.6667 × 4] ÷ 0.12 = (4 + 2.6667) ÷ 0.12 = 6.6667 ÷ 0.12 = ₹55.56 (approx.).
  4. Since r < k, the firm is a declining firm. Optimal payout is 100%.
  5. Check at 100% payout: D = 8, so P = 8 ÷ 0.12 = ₹66.67, which is higher than ₹55.56.
  6. (b) r = 0.12. r ÷ k = 1.
  7. P = [4 + 1 × 4] ÷ 0.12 = 8 ÷ 0.12 = ₹66.67 (approx.).
  8. Since r = k, the firm is a normal firm and any payout gives the same price.

Answer: (a) P ≈ ₹55.56; r < k, so the optimal payout is 100% (price would be ₹66.67). (b) P ≈ ₹66.67; r = k, so the payout ratio does not matter.

Exam tips

  • Write the formula first with the symbols defined. Examiners award marks for the correct formula even if arithmetic slips.
  • Always finish with the firm type and the optimal payout. Many questions ask for it in the last part.
  • In theory questions, link each assumption to a limitation, for example constant r and k versus real-world changes.
  • Compare Walter's model with Gordon's model and the Modigliani-Miller view. Both are frequently asked as short notes.
  • Keep two decimal places in the final price, and show the ₹ sign.

Practice questions from Dividend Decisions

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.

Walter's Model: frequently asked questions

What is the formula for share price in Walter's model?

P = [D + (r ÷ k)(E − D)] ÷ k. Here D is dividend per share, E is earnings per share, r is the return on investment and k is the cost of capital. Use decimals for r and k.

What are the main assumptions of Walter's model?

All financing is from retained earnings, with no new debt or equity. r and k stay constant, the firm has an infinite life, and E and D do not change. Questions often ask you to list these and then criticise them.

What is the optimal dividend payout in Walter's model?

It depends on r and k. If r > k, retain everything (0% payout). If r < k, distribute everything (100% payout). If r = k, there is no optimal payout.

How is Walter's model different from Modigliani-Miller?

Walter says dividend policy changes share value, depending on r and k. Modigliani-Miller says that under perfect market conditions, dividend policy does not change value. Walter's model is therefore a relevance theory.