CA Intermediate · Financial Management and Strategic Management · Dividend Decision
Under Walter's model, a firm has a return on investment (r) greater than its cost of capital (Ke). Which dividend payout policy maximises the market price per share of this firm?
Zero payout is optimal. In Walter's model, when the firm's return on investment exceeds its cost of capital, retained earnings generate more value than shareholders could obtain elsewhere, so market price per share is maximised by retaining all earnings and paying no dividend.
- AZero payout, retaining all earningsCorrect
- B100% payout of earnings
- C50% payout of earnings
- DPayout equal to the cost of capital
Explanation
In Walter's model, when r > Ke the firm is a growth firm. Retained earnings earn more than shareholders could earn elsewhere, so share price rises as payout falls. The optimum payout is therefore zero. A 100% payout is optimal only when r < Ke.
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