Question

If a firm has $k_e$ < r the Walter's Model suggests for ____________.

• A. 0% Payout
• B. 100% Payout
• C. 50% Payout
• D. 25% Payout

Answer 1

Answer: (A)

0% Payout

Walter's model supports the principle that dividends are relevant. The investment policy of a firm cannot be separated from its dividend policy and both are inter-related.

When $r>$ k${}_e$ the value of shares is inversely related to the D/P ratio. As the D/P ratio increases, the market value of the shares decline. Its value is the highest when D/P ratio is 0. So, if the firm retains its earning entirely, it will maximise the market value of the shares. The optimum payout ratio is zero.