Which of the following assumptions are based on Walter’s Model of dividend?

(A) Internal Financing
(B) 100 percent pay out ratio
(C) The firm has a short term life
(D) Constant EPS and dividend per Share (DIV)
(E) Increasing return and minimise cost of Capital

Choose the correct answer from the options given below:

Correct option is D

Walter’s Model of Dividend is a theory proposed by James E. Walter, which states that dividend policy affects the value of a firm. It assumes that all financing is done through retained earnings (internal financing) and that firms have constant earnings per share (EPS) and dividends per share (DPS). The model suggests that the relationship between a firm's return on investment (r) and its cost of capital (k) determines whether dividends should be paid or reinvested.

The assumptions of Walter’s Model include:

1. (A) Internal Financing: The firm relies only on retained earnings for financing investments; it does not use external sources like debt or equity.

2. (B) 100 Percent Payout Ratio: Walter’s model assumes that firms either distribute all their earnings as dividends or reinvest the entire amount, making the payout ratio either 0% or 100%.

3. (D) Constant EPS and Dividend per Share (DIV): The model assumes that earnings per share remain constant, and dividend per share is based on the earnings reinvested or distributed.

Information Booster:

1. Walter’s Model is one of the classical dividend theories, which explains how dividend policy impacts a firm's valuation.

2. The model works under the assumption that firms are either growth firms (r > k), normal firms (r = k), or declining firms (r < k), where "r" is the return on investment, and "k" is the cost of capital.

3. If a firm's return on investment (r) is greater than the cost of capital (k), it should retain earnings rather than distribute dividends to maximize shareholder wealth.

4. The model is applicable only when earnings are retained and reinvested at a constant rate.

5. It assumes that the firm does not raise capital externally, meaning no new debt or equity is issued.

Additional Knowledge:

1. (C) The firm has a short-term life:

   • This is incorrect because Walter’s Model assumes that a firm exists indefinitely and does not have a limited lifespan. The model is based on constant earnings and dividends over an infinite time horizon.

2. (E) Increasing Return and Minimize Cost of Capital:

   • Walter’s Model does not explicitly assume that firms aim to increase their return or minimize capital costs. Instead, it focuses on how dividend decisions affect firm valuation based on existing return on investment (r) and cost of capital (k).

   • The cost of capital (k) is considered constant, and the return on investment (r) is based on available opportunities rather than an active effort to increase or minimize costs.​