CA Intermediate · Financial Management and Strategic Management · Dividend Decision
Under the Walter model, the value of a share is P = [D + r(E − D)/Ke] / Ke. A firm has E = ₹10 per share, Ke = 10% and r = 10%. What is the market price per share if the payout ratio is 40%?
The price is ₹100. Dividend is ₹4 and retention ₹6. Because the return on investment equals the cost of capital (10%), dividend policy is irrelevant in the Walter model, so price equals EPS divided by Ke, which is 10/0.10 = ₹100.
- A₹100Correct
- B₹90
- C₹110
- D₹104
Explanation
D = 40% of 10 = ₹4. Retained = ₹6. With r = Ke = 10%, P = [4 + 0.10(6)/0.10]/0.10 = (4 + 6)/0.10 = ₹100. Check: when r = Ke, price is the same at any payout, E/Ke = 10/0.10 = ₹100. A price of ₹90 results if retained earnings are ignored, e.g. 4/0.10 = 40 is far lower, so such options reflect missed retention terms.
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