CA Inter P6 · Chapter 8 · Question 2 of 8
According to Walter's model, if a firm's internal rate of return (r) is greater than its cost of equity (Ke), the optimum dividend payout ratio is:
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: A) Zero, that is, retain all earnings
Explanation
Under Walter's model, if r > Ke the firm is a growth firm and creates more value by reinvesting earnings than shareholders could earn themselves. The share price is maximised at a zero payout. If r < Ke the optimum payout is 100%, and if r = Ke the payout is irrelevant.
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