Skip to content

CA Final · Advanced Financial Management · Financial Policy and Corporate Strategy

Kaveri Engineering Ltd expects earnings per share of Rs 20 this year and follows Walter's model. Its return on investment (r) is 15% and cost of equity (ke) is 10%. Under Walter's model, which dividend payout policy maximises the market price per share, and what is the price at that policy?

Zero payout with a price of Rs 300. Because the return on investment of 15% exceeds the cost of equity of 10%, retaining earnings creates value in Walter's model. Price equals (r/ke) times EPS divided by ke, which is 1.5 times 20 divided by 0.10, giving Rs 300.

  1. A100% payout; Rs 200
  2. BZero payout; Rs 300Correct
  3. CZero payout; Rs 200
  4. D50% payout; Rs 250

Explanation

Since r (15%) exceeds ke (10%), the firm is a growth firm and should retain all earnings, so payout is 0%. Price = [D + (r/ke)(E - D)] / ke = [0 + (0.15/0.10) x 20] / 0.10 = 30 / 0.10 = Rs 300. At 100% payout the price would be 20/0.10 = Rs 200, which ignores the value from reinvestment at a higher return.

Did you get it right without looking?

One question tells you little. A timed set on Financial Policy and Corporate Strategy shows your real accuracy, how long you take and where you lose marks.

Practise Financial Policy and Corporate StrategyFree diagnostic mock

More Financial Policy and Corporate Strategy questions