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Walters model on dividend policy assumes that.
Answer & Solution
Correct Answer:
Option
A
Walter's Model is a dividend relevance theory proposed by Professor James E. Walter.
It emphasizes the relationship between the firm’s internal rate of return (r), cost of capital (k), and dividend policy in determining the market price of shares.
Key Assumptions of Walter’s Model:
1. The firm is financed entirely by equity and does not use debt.
2. The internal rate of return (r) and the cost of capital (k) are constant.
3. All earnings are either distributed as dividends or reinvested immediately.
4. The firm has a very long or potentially infinite life.
5. The firm offers an increasing amount of dividend per share at a given level of price per share, reflecting how dividend policy influences valuation in the model.
Why Other Options Are Incorrect:
Option B: The model assumes the firm has an infinite life, not a finite one.
Option C: Walter’s model is based on the assumption that the cost of capital remains constant.
Option D: This statement is related to balance sheet accounting and is not relevant to dividend policy under Walter's model.
Hence, the correct answer is: the firm offers an increasing amount of dividend per share at a given level of price per share.
It emphasizes the relationship between the firm’s internal rate of return (r), cost of capital (k), and dividend policy in determining the market price of shares.
Key Assumptions of Walter’s Model:
1. The firm is financed entirely by equity and does not use debt.
2. The internal rate of return (r) and the cost of capital (k) are constant.
3. All earnings are either distributed as dividends or reinvested immediately.
4. The firm has a very long or potentially infinite life.
5. The firm offers an increasing amount of dividend per share at a given level of price per share, reflecting how dividend policy influences valuation in the model.
Why Other Options Are Incorrect:
Option B: The model assumes the firm has an infinite life, not a finite one.
Option C: Walter’s model is based on the assumption that the cost of capital remains constant.
Option D: This statement is related to balance sheet accounting and is not relevant to dividend policy under Walter's model.
Hence, the correct answer is: the firm offers an increasing amount of dividend per share at a given level of price per share.
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LoginHere's a more detailed look at the assumptions:
Retained Earnings Financing:
The model assumes that firms finance all investment projects solely using retained earnings, without resorting to external sources like debt or new equity.
Constant Rate of Return (r):
Walter's model assumes that the internal rate of return (r), or the rate at which a firm can reinvest retained earnings, remains constant over time.
Constant Cost of Capital (k):
The model also assumes that the firm's cost of capital (k), or the rate at which investors expect to be compensated for their investment, remains constant.
All Earnings are either distributed or reinvested:
The model assumes that all earnings are either distributed as dividends or reinvested immediately, meaning there is no accumulation of undistributed earnings.
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