Distributing the dividends and retaining the earnings, Financial Management

The Walter's model, thus relates the question of distributing the dividends and retaining the earnings to the investment opportunities that are available with the firm.

(i) If a firm has sufficient profitable investment opportunities it will be able to earn more than what the investors expect as r> Ke that is return on investment is more than the cost of capital. Such firms are described the growth firms. For growth firms the best possible dividend policy would be given by Dividend Payout Ratio of zero that is they would retain their entire earnings. The market worth of the shares will be maximized as a result.

(ii) On the contrary if a firm doesn't have profitable investment opportunities that are when r is less than Ke the shareholders will be better off if the earnings are paid out to them consequently that they are able to earn a higher return by investing the funds elsewhere. In such a case the market cost of shares will be maximised by the distribution of the entire earnings as dividend. For such firms the best possible dividend policy would be given by Dividend Payout Ratio of 100%.

Posted Date: 8/5/2013 3:21:55 AM | Location : United States







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