Answer to Question #176444 in Economics for Mayuri

Question

3. Walter and Gordon model analyse the impact of distribution of dividends on the

valuation of the firm but the formula used in both the cases are different. CompanyABC Ltd wanted to evaluate the price of the share in both cases. The company earns ₹

50 per share and expects the same for the next year. The cost of capital to the firm is

11%. The company earns return on investment of 15% and the firm is planning

dividend payout ratio of 60%. Calculate:

a. Price of the share using Walter Model. Comment on the relationship between return on

investment and cost of capital in the case above and decision of the firm whether

dividend is to be declared or not. (5 Marks)

b. Price of the share using Gordon model. Comment on the relationship between return on

investment and cost of capital in the case above and decision of the firm whether

dividend is to be declared or not. (5 Marks)

Answer 1

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