Walter Dividend Model Assumptions and Criticism
Walter Dividend Model: The model states that firm’s rate of return and cost of capital determines the dividend policy that ultimately leads to maximization of shareholder’s wealth.
This model is given by James E. Walter. According to him, the choice of dividend policy affect the value of the firm. And in determining dividend policy rate of return and cost of capital play an important role.
Walter Dividend Model Assumptions
- Constant Return and Cost of Capital: Walter Model assumes that returns and discount rate remains constant.
- Internal Financing: This model assumes that firm finances all its investments and projects through internal financing that is retained earnings.
- Earnings and Dividends remain constant: The model is based on the assumption that the earnings in the beginning and dividend remains constant and never changes.
- 100% retention or payout ratio: It assumes that either firm completely retained the earnings or firm distribute all their earnings.
- Perpetual succession: The firm has infinite life.
Application of Walter Model
For Growth firms – Internal Rate of Return is greater than cost of capital (r>k)
For normal firms – Internal rate of return is equal to cost of capital (r=k)
Declining Firms – Rate of return is less than the opportunity cost of capital (r<k)
Walter Dividend Model Criticism
- The model assumes that there is constant cost of capital. But in reality as the firm’s risk class changes the cost of capital also changes.
- Walter model assumes that firms earn constant return. However, when firms made more investments, the return decreases.
- Model says firms go only for internal financing. In reality firms use both internal as well as external financing.