Dividend Policy

Walter model is one of my favourites and it makes me like a Tycoon

1. When ROI > Ke Here the firm made profits which can cover up the shareholders payback. But the company wants to retain it further one more year or more, reinvest it back and give the investors more money as a return. The returns the company is promising is more than the returns an investor could get if he invests with his dividend income. Here Dividend payout is 0%

2. When ROI=Ke Here the firm declares 0-100% dividend payout because if the firm has a chance to double the returns, it will retain it, or else, if the investor can earn it, it will allow them to do so. Depending upon the reinvestment criteria without raising additional funds, it will declare dividends.

3. When ROI < Ke Here, Since the firm is not doing well, it will declare 100% dividend payout because the investor has better chances of investing it somewhere else. 

Mr. Karan, sorry here R=IRR. The book I’m referring to had printed it as ROI. IRR = 0 NPV while, Ke can have 0 NPV, +ve NPV or Negative NPV. (There can be a negative IRR as well if there are unconventional Cashflows). Walter assumed ‘r’ at different rates and also assumed Ke t different to simulate in his model to see if these values will increase or decrease in the share price along with increase decrease in dividend payout ratio. He found out both of them are inverselyrelated.

When R>Ke, With increase in dividend payout ratio, the market price of share is falling.

When R<Ke, With increase in dividend payout ratio, the market price of share is increasing.

When R=Ke, The market price of share is constant with increasing dividend payouts.

The problem here, it is assumed that this model is used for only all equity companies which has no debt.

The next problem is IRR is constant.