Walter's Dividend Model
The term dividend refers to that part of after-tax profit which is allotted to the owners (shareholders) of the company. The unallocated part of the profit is known as Retained earnings. Higher the dividend payout, lower will be held back earnings.
The dividend policy of a company refers to the opinions and policies of the management with respect of distribution of dividends. The dividend policy of a company should aspire at shareholder's wealth maximization.
If the company is confident of bringing forth more than market returns then only it should retain higher profits and pay less as dividends (or pay no dividends at all), as the shareholders can expect higher share prices established on higher RoI of the company. All the same, if the company is not convinced of bringing forth more than market returns, it should pay out more dividends. This is done for two grounds:
i) The shareholders opt early receipt of cash.
ii) The shareholders can invest this cash to generate more returns.
Over the years, assorted models have been developed that demonstrate the relationship among dividends and stock prices. The most substantial of them is Walter Model:
Walter Model
Prof James Walter invented an easy and simple formula to demonstrate how dividend can be employed to maximize the wealth position of shareholders. He considers dividend as one of the significant components determining the market valuation. As per Walter, in the long run, share prices reflect the present value of future stream of dividends. Retained net income influence stock prices only by means of their effect on further dividends.
Assumptions:
The company is a going have to do with with perpetual life span. The exclusive source of finance is retained earnings. i.e. no other substitute means of financing. The cost of capital and return on investment are invariable throughout the life of the company.
As per Walter Model,
P = [D + (E - D) x ROI / Kc] / Kc
P= Market price per share E= net income per share
D = Dividend per share Kc= Cost of Capital (Capitalization rate)
ROI = Return on Investment (also called return on internal retention)
The model considers internal rate of return (IRR), market Capitalization rate (Kc) and dividend payout ratio in determination of share prices. However, it ignores various other components determining the share prices. It fails to appropriately compute prices of companies that resort to external sources of finance. Further, the presumption of constant cost of capital and constant return are impossible.
If the internal rate of return from retained net income is higher than the market capitalization rate then the value of ordinary shares would be high even if the dividends are low. All the same, if the RoI within the business is less than what the market demands then the value of shares would go down. In this type of cases, the shareholders would anticipate a higher dividend.
If RoI > Kc, Price would be high even if Dividends are low.
Walter model describes why market price of shares of developed firms are high even if dividend payout is low. It also explains why the market prices of shares of certain companies which pay higher dividend and hold low profits are high.
The dividend policy of a company determines what proportion of net income is assigned to the shareholders by way of dividends, and what proportion is treated back for reinvestment purposes. For the ground that the primary objective of financial management is to maximize the market value of equity shares, one key area of study is the relationship among the dividend policy and market price of equity shares.
There are four models accessible to prove the above relationship, these are in brief described as follows:
Traditional model:
As per this model founded by Graham and Dodd, the market price of the shares will increase when a company announces a dividend instead of when it does not.
Numerically,
P=m (D+E/3)
where:
P is the market price per share.
E is the earning per share.
D is the dividend per share.
m is a multiplier.
Walter model: As per this model founded by James Walter, the dividend policy of a company has an impact on the share valuation.
Numerically,
P=(D+(E-D) r/k)/k
where:
P, D, E have the same connotations as above and r is the IRR on the investments and k is the cost of capital.
The impact of dividend payment on the share price is considered by comparing the rate of return with the cost of capital.
ñ When r>k, the price per share raises as the payout ratio decreases and optimal payout ratio is nil.
ñ When r=k, the price per share does not vary with the changes in the payout ratio and optimal payout ratio doesn't exist.
ñ When r<k, the price per share raises as the payout ratio raises and optimal payout ratio is 100%.
Gordon model:
As per this model founded by Myron Gordon, the dividend policy of the company has an impact on share valuation.
Quantitatively P= Y (1-b)/(k-br)
Where P is the price per share
Y is the net income per share
b is the retention ratio
1-b is the payout ratio
br is the growth rate
r is the return on investment
k is the rate of return required by shareholders
On comparing r and k, the relationship among market price and the payout ratio is exactly the same as compared to the Walter model.
ExpertsMind.com - Walter Dividend Model Assignment Help, Walter Dividend Model Homework Help, Walter Dividend Model Assignment Tutors, Walter Dividend Model Solutions, Walter Dividend Model Answers, Dividend Decisions Assignment Tutors