CA Intermediate · Financial Management and Strategic Management · Dividend Decision
Under the Walter model of dividend policy, a firm's market price per share is maximised by distributing no dividend at all when:
The Walter model says zero dividend payout maximises share price when the firm's return on investment exceeds its cost of capital, because retained earnings then earn more than shareholders could obtain elsewhere. When r is below k, full payout is best, and when r equals k, payout is irrelevant.
- Aits return on investment (r) is less than its cost of capital (k)
- Bits return on investment (r) equals its cost of capital (k)
- Cits return on investment (r) is greater than its cost of capital (k)Correct
- Dits dividend payout ratio is exactly 50%
Explanation
In Walter's model, if r > k the firm earns more on retained funds than shareholders could earn elsewhere, so retention raises share price and the optimal payout is zero. If r < k, the optimal payout is 100%, and if r = k the price is unaffected by payout. Option A describes the full-payout case.
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