1. Walter’s Theory

2. Dividend Theory

3. Issues in Dividend Policy
Earnings to be Distributed – High Vs. Low Payout.
Objective – Maximize Shareholders Return.
Effects – Taxes, Investment and Financing Decision.

4. Walters Model
Assumptions
Valuation
Optimum Payout Ratio
Criticism

5. Assumptions Internal Financing- debt or new equity is not issued.
Constant Return and Cost of Capital
100% Payout or Retention
Constant EPS and DIV – beginning earnings and dividends never change.
Infinite Time – The firm has a very long or infinite life

6. Optimum Payout Ratio Growth Firms – Retain all earnings ( r>Ke)
Ample opportunities yielding higher returns than opportunity cost of capital.
These firms are able to reinvest earnings at a rate (r) which is higher than Ke.
Optimum pay out ratio is Zero.
Normal Firms – ( r= Ke) No effect
Most of the firms do not have unlimited surplus generating investment opportunities.
r=Ke , the dividend has no effect on market value per share in Walter’s model.
No unique optimum pay out ratio for normal firm.
Declining Firms – Distribute all earnings (r < Ke)
Some firms do not have any profitable investment opportunities to invest earnings.
Optimumpay out ratio for declining firm is 100%

7. Valuation
Market price per share is the sum of the present value of the infinite stream of constant dividends and present value of the infinite stream of capital gains. r
D (E-D) Ke
P =
P= market price per share
r= internal rate of return
Ke = cost of equity capital
D= Dividend
E=Earning per share.

8. Problem
Given the following information about Z ltd., show the effect of the dividend policy on the market price of its shares, using Walter’s model.
Equuity capitalization Rate Ke =12%
EPS=Rs.8
Assume return on investment are as follows:
r=15%
r = 10%
Dividend pay out ratios : Zero, 25%, 50%, 75% and 100%

9. D/P =0 DPS =0
0+(0.15/0.12)(8-0) P=
0.12
= Rs.83.3

10. Solution 1. r=15%, Ke=12% D/P =0 DPS =0 0+(0.15/0.12)(8-0)
= Rs.83.3
2. D/P =25% DPS =2 (8*25/100)
2+(0.15/0.12)(8-2)
= Rs.79
3. D/P =50% DPS =4
4+(0.15/0.12)(8-4) P=
0.12
= Rs.75
2. D/P =75% DPS =6 (8*50/100)
6+(0.15/0.12)(8-6)
= Rs.71
3. D/P =100% DPS =6 (8*100/100)
8+(0.15/0.12)(8-8)
= Rs.66.66

11. r=10%, Ke=12% 1.Rs.56 -0 2. Rs.61-50% 3.Rs.67-100% 4. Rs. 58-25%

12. Criticism No external Financing Constant Rate of Return
Constant opportunity cost of capital