Question

If $k_e$ = r,

Under Walter's Model, which of the following is irrelevant?

• A. Earnings per share
• B. Dividend per share
• C. DP Ratio
• D. None of the above

Answer 1

The correct option is C DP Ratio

Walter's formula :

P = D/k + [r/k(E-D)] /k or,

P = [D + r/k(E-D)]/k

where,

P= market price per share

D=dividend per share

E= earnings per share

r= internal rate of return (IRR) of the firm

k= cost of capital of the firm.

In the actual market scenario there are three types of firms

• Growth firm
• Normal firm
• Declining firm
  

In case of a normal firm the internal rate of return (r) = the cost of capital (ke). It shows that the firm is making a return that a normal shareholder is already making from his funds. There would be no inertia to the shareholder to even think about purchasing or investing in such a share. He would not be concerned with the dividend payout policy of the company and hence there would be no influence of the dividend payout on the market price of the share and it would become irrelevant. In this scenario the total of the numerator would always be equal to the total earnings, because when ke = r then the retained earnings would get multiplied by $1$ and so basically we would be capitalising the total earnings by the cost of capital.