CS Executive · Corporate Accounting and Financial Management · Dividend Decisions
A firm has r = 8%, k = 12% and EPS of Rs 12. Under Walter's model, which dividend payout ratio gives the highest share price, and what is that price?
Full payout (100%) maximises price at Rs 100. Because the return of 8% is below the 12% cost of capital, retained earnings destroy value, so all earnings should be distributed. Price is then E/k = 12/0.12 = Rs 100.
- A0% payout; Rs 66.67
- B100% payout; Rs 100Correct
- C100% payout; Rs 150
- D50% payout; Rs 83.33
Explanation
Since r < k, retention lowers value, so 100% payout is best. With D = 12, P = [12 + (0.08/0.12)(0)] / 0.12 = Rs 100. With 0% payout, P = [0 + (2/3)(12)]/0.12 = 8/0.12 = Rs 66.67, which is the worst case.
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