Prof. James E. Walter argues that the choice of dividend policies almost always affect the value of the firm. His model is based on the following assumptions:
1. Internal financing: The firm finances all investment through retained earnings; i.e. debt or new equity is not issued.
2. Constant return and cost of capital: the firm’s rate of return, r , and its cost of capital, k , are constant.
3. 100% payout or retention: All earnings are either distributed as dividends or reinvested internally immediately.
4. Infinite time: the firm has infinite life
Valuation Formula: Based on the above assumptions, Walter put forward the following formula:
P = DIV + (EPS-DIV) r/k
P = market price per share
DIV= dividend per share
EPS = earnings per share
DIV-EPS= retained earnings per share
r = firm’s average rate of return
k= firm’s cost o capital or capitalisation rate