SUBMITTED TO ASHISH PANDEY SIR MBA DEPARTMENT ,SRGI SUBMITTED BY: Deepika Shrivastava MBA2 semester

Professor James E Walter argues that the choice of dividend may affect the value of the firm.The model shows the relationship between the firms rate of return, r,and its cost of capital , k, in determining the dividend policy that will maximize the wealth of shareholders.

Walters model is based on the following assumptions; Internal Financing: the firm finance or raises capital by retained earnings or plough back of profits,not by issuing shares or debentures.

 Constant return and cost of capital:The firmss rate of

return ,r and its cost of capital,k are constant. 100% payout or retention:All earnings are either distributed as dividends or reinvested internally immediately. Constant EPS and DIV:The values of EPS and DIV may me changed in the model to determine the results,but any given values of EPS and DIV are assumed constant. Infinite time:The firm has a very long or infinite life.

 Walters formula to determine the market price per

share is as follows: P=DIV/K + r(EPS-DIV)/k/k Where P=market price per share DIV=dividend per share EPS=earnings per share R= firms rate of return K=firms cost of capital.

Irms is zero.

GROWTH FIRM:Internal rate more than oppurtunity cost of capital(r>k) High yeiding returns than oppurtunity cost of capital The optimum payout ratio for growth firms is zero. NORMAL FIRMS: Intenal rate is equal to oppourtunity cost of capital.(r=k) Dividend policy will not affect the market value of shares as the shareholders will get the same return from the firm as expected out of them.for such firms there is no optimum dividend payout and the value of the firm woul d not change with the change in dividend rate. DECLINING FIRMS:(r<k) Internal rate less than oppurtunity cost of capital

The shareholders would stand to gain if the firm distributes its earnings.For such firms the optimum payout would be 100% and the firm should distribute its entire earnings as dividends. CRITISISM Of WALTERS MODEL 1.The basic assumptions that investments are financed through retained earnings onlyis rarely true in the real corporate world. 2.The internal rate of rate also does not remains constant ie.r .With increased investment the rate of return also changes.for ex if the firm has invested 1000o rs at 10% sowiilget in return 1000 and if invested 20000 at same% but will get 2000 so rate of retun changes and not remains constant.

 3.The assumption that cost of capital ie.k will remain

constant also does not hold good.As a firms risk pattern does not remain constant ,it is not proper to assume k always constant.