CA Intermediate · Financial Management and Strategic Management · Dividend Decision
Under Walter's model of dividend policy, a firm's market price per share will be maximised by paying no dividend (full retention) when:
Under Walter's model, a firm should retain all earnings and pay no dividend when its return on investment exceeds its cost of capital, because reinvested funds earn more than shareholders could earn elsewhere, which raises the market price of the share.
- AThe return on investment (r) is greater than the cost of capital (Ke)Correct
- BThe return on investment (r) is less than the cost of capital (Ke)
- CThe return on investment (r) equals the cost of capital (Ke)
- DThe firm has no external financing available
Explanation
In Walter's model, if r > Ke the firm is a growth firm and earns more on retained funds than shareholders could elsewhere, so the optimal payout is zero. If r < Ke, the optimal payout is 100%. If r = Ke, the dividend policy is irrelevant to the share price.
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