CA Intermediate · Financial Management and Strategic Management · Dividend Decision
Under the Walter model, a firm's market price per share is computed as P = [D + (r/Ke)(E − D)] / Ke. If a firm has r greater than Ke (a growth firm), which dividend payout policy maximises the market value of its shares?
Under the Walter model, a growth firm with r greater than Ke maximises share value by retaining all earnings, that is, a zero payout. Retained funds earn more than shareholders' required return, so every rupee kept back adds more value than paying it out as dividend.
- AZero payout, retaining all earningsCorrect
- B100% payout, distributing all earnings
- C50% payout irrespective of r and Ke
- DPayout equal to the cost of equity
Explanation
When r > Ke, each rupee retained earns more than shareholders could earn elsewhere. In P = [D + (r/Ke)(E − D)] / Ke, the retained portion is multiplied by r/Ke > 1, so price rises as D falls. The optimum is therefore zero payout. A 100% payout is optimal only when r < Ke.
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