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 !Walter's Model
 2.Gordon's Model



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 Modigliani - Miller model
 Walterƍs Model?
 Prof. James E Walter argues that the choice of dividend payout ratio

almost always affects the value of the firm. He has studied the

relationship between Internal rate of return (r) and cost of capital (k)

in determining optimum dividend policy which maximizes the wealth

of shareholders.

 Walters models is based on the following assumptions

 the firm finance its entire investments by means of retained earning

only.

 Internal rate of return (r) and cost of capital (k) of the firm remains

constant.
 ›he firms earning are either
distributed as dividend or
reinvested internally
 Beginning earnings and
dividends of the firm will never
change.
 ›he firm has a very long or
infinite life.
 ˜a


ü ˜
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P= Market price per share.

DIV= dividend per share
EPS= earning per share

r= Internal rate or return

k= cost of capital.


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 ptimum Payout Ratio
 Growth Firms (r>k) Ɗ Retain all earnings
(ptimum payout ratio is 0%)
 Normal Firms (r=k) Ɗ No influence (All the pay
out ratio is optimum)
 Declining Firms (r<k) Ɗ Distribute all earnings
(ptimum payout ratio is 100%)
 riticism

 No external Financing
 onstant Rate of Return
 onstant opportunity cost of
capital
 Gordon's Model
Another theory, which contents that dividends are relevant, is the

Gordonƍs model. ›his model says that dividend policy of a firm affects

its value.It is based on the following assumptions.

 ›he firm is an all equity firm (no debt)

 ›here is no outside financing and all investments are financed

exclusively by retained earnings.

 Internal rate of return (r ) of the firm remains constant.

 ost of capital (k ) of the firm also remains same regardless of the

changes in the risk

 ›he firm derives its earnings in
perpetuity.
 ›he retention ratio (b) once decided
upon is constant. ›he growth rate (g) is
also constant (g= br).
 orporate tax does not exist.
Gordon used the following formula to
find out price per share
r

 Gordon used the following
formula to find out price per
share

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P =Market price per share
k = cost of capital
EPS = earnings per share
b = retention ratio
(1-b) = Dividend payout ratio
r = internal rate of return
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 Growth Firms (r>k) Ɗ Retain all earnings
(ptimum payout ratio is 0%)
 Normal Firms (r=k) Ɗ No influence (All the pay
out ratio is optimum)
 Declining Firms (r<k) Ɗ Distribute all earnings
(ptimum payout ratio is 100%)
 ›hus ,the Gordonƍs modelƍs conclusions about
dividend policy are similar to that of Walter.
›his similarity is due to the similarities of
assumptions of both the models.
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Assumption:
 apital markets are perfect. (No
investor can influence the market price
of the share)
 ›here are no taxes
 ›he firm has a fixed investment policy.
 Flotation costs does not exist.

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