myz-vgb.ru A Business Encyclopedia

Walter’s Model

Definition: According to the Walter’s Model, given by prof. James E. Walter, the dividends are relevant and have a bearing on the firm’s share prices. Also, the investment policy cannot be separated from the dividend policy since both are interlinked.

Walter’s Model shows the clear relationship between the return on investments or internal rate of return (r) and the cost of capital (K). The choice of an appropriate dividend policy affects the overall value of the firm. The efficiency of dividend policy can be shown through a relationship between returns and the cost.

  • If r>K, the firm should retain the earnings because it possesses better investment opportunities and can gain more than what the shareholder can by re-investing. The firms with more returns than a cost are called the “Growth firms” and have a zero payout ratio.
  • If r<K, the firm should pay all its earnings to the shareholders in the form of dividends, because they have better investment opportunities than a firm. Here the payout ratio is 100%.
  • If r=K, the firm’s dividend policy has no effect on the firm’s value. Here the firm is indifferent towards how much is to be retained and how much is to be distributed among the shareholders. The payout ratio can vary from zero to 100%.

Assumptions of Walter’s Model

  1. All the financing is done through the retained earnings; no external financing is used.
  2. The rate of return (r) and the cost of capital (K) remain constant irrespective of any changes in the investments.
  3. All the earnings are either retained or distributed completely among the shareholders.
  4. The earnings per share (EPS) and Dividend per share (DPS) remains constant.
  5. The firm has a perpetual life.

Criticism of Walter’s Model

  1. It is assumed that the investment opportunities of the firm are financed through the retained earnings and no external financing such as debt, or equity is used. In such a case either the investment policy or the dividend policy or both will be below the standards.
  2. The Walter’s Model is only applicable to all equity firms. Also, it is assumed that the rate of return (r) is constant, but, however, it decreases with more investments.
  3. It is assumed that the cost of capital (K) remains constant, but, however, it is not realistic since it ignores the business risk of the firm, that has a direct impact on the firm’s value.

Note: Here, the cost of capital (K) = Cost of equity (Ke), because no external source of financing is used.

Leave a Reply

Your email address will not be published. Required fields are marked *

Shares

Related pages


net profit margin ratio formulaexpansionism definitiondistinguish between explicit and implicit costwhat is total utility in economicsadvertising elasticity of demandequity theory relationshipsforced distribution method of performance appraisalhygiene theory motivationsupervisor meaning in hindidefinition of elasticity in economicsparticipative leadershipdefine retained profitdefine ethocentriclist of inelastic productshr dashboard formatmeaning of laissez faire leadership styledifferent theories of dividend policycamel rating definitionprimal linear programmingisoquant grapherg motivation theorymeaning of snowballhedge knight definitionmeaning of sbuexplain the trend projection method of demand forecastingdescribe classical conditioningforeign exchange market macroeconomicsdefinition of bureaucracy by max weberwhat does demand pull inflation meanbank lockbox systemcyclical unemploymentmarkups meaninggdp gnp ndp nnp definitionjohri windowwhat is ethnocentricitymeaning retrenchmentexplain the process of job evaluationquota samplescharacteristics of a monopoly market structuredefinition of laissez faire leaderretained earnings definition accountingmacgregor's theory x and theory yformula of asset turnovercharacteristics of an oligopolypiecework rateopportunity entrepreneur definitionformula of asset turnover ratiosensitivity analysis for npvwhats samplingnet asset turnover definitionpremature evaluation meaninghrm audittall organizational structure advantages and disadvantagesmotivation theory vroommarket morphology in economicsconstant sum scale exampleteleological systemsreinforcements meaningpull factors definitionthe recessionary phase of the business cycle is characterized bythe principles of scientific management summarydeontological definitionexample of disguised unemploymentwhat is cost push and demand pull inflationmcclelland's three needs theorypac man definitionwhat is retained incomeexplain equity theoryhuman resources metrics dashboardconcept of multiplier in economicstotal utility and marginal utility relationshipthe neoclassical modelcost of stepping stones