Walter’s Model – Question Paper
Section A: Multiple Choice Questions (4 Marks)
1. 1. According to Walter’s Model, if the firm’s internal rate of return (r) is greater than its
cost of capital (k), the firm should:
a) Pay out maximum dividend
b) Retain all earnings
c) Maintain constant dividend payout
d) Borrow funds for investment
Answer: b) Retain all earnings
2. 2. Which of the following is not an assumption of Walter’s Model?
a) The firm uses only retained earnings for investment
b) The firm has an infinite life
c) The cost of capital (k) changes with time
d) The rate of return (r) remains constant
Answer: c) The cost of capital (k) changes with time
3. 3. In Walter’s Model, the relationship between dividend policy and firm’s value depends
primarily on:
a) Market share and competition
b) Rate of return (r) and cost of capital (k)
c) Debt-equity ratio
d) Dividend history
Answer: b) Rate of return (r) and cost of capital (k)
4. 4. The main criticism of Walter’s Model is that it:
a) Ignores retained earnings
b) Assumes external financing
c) Assumes constant r and k
d) Fails to link dividend and firm value
Answer: c) Assumes constant r and k
Section B: Long Answer Questions
5. 1. Explain in detail the Walter’s Model of dividend policy. Discuss its assumptions,
formula, and implications of different relationships between rate of return (r) and cost
of capital (k).
6. 2. Discuss the limitations and criticisms of Walter’s Model. How do unrealistic
assumptions affect its practical applicability in real business situations?
Section C: Numerical Question
1. Santosh Ltd. earns ₹5 per share, has a cost of equity capital (Ke) of 10%, and the internal
rate of return (r) is 18%. Calculate the market price per share when the dividend payout
ratio is 25%, using Walter’s Formula.
Formula: P = [D + (E - D)r / Ke] / Ke
Given:
E = ₹5
r = 18% (0.18)
Ke = 10% (0.10)
Dividend payout = 25% of ₹5 = ₹1.25
Calculation:
P = 1.25 + ((5 - 1.25) × 0.18 / 0.10)
P = 1.25 + (3.75 × 1.8) = 1.25 + 6.75 = ₹8.00
Value per share = ₹80
Conclusion: Since r > Ke, the firm should retain earnings (0% payout) for maximum firm
value.