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What are the assumptions of Walter’s Dividend Model?
Walter’s model is a dividend theory that considers the internal rate of return (IRR) and cost of capital to derive the valuation of a firm. The internal rate of return and cost of capital remains constant for the entire cycle of calculation. However, according to Walter’s model, the Earnings per share (EPS) and dividend per share may change.
Assumptions of Walter's Dividend Model
Walter’s model of dividend theory is based on some assumptions, which are discussed below.
Internal Financing
The entire cost of a project is paid via internal financing and no new debt or equity is used in financing a firm’s project.
To be considered by Walter’s model, a company should be healthy enough not to require debt or equity for financing its projects.
As no debt or equity is invested, the rate of return originating from the investment is always internal or company-specific.
Complete Retention or Payout
Walter’s model requires the dividends either to be 100% distributed or completely used for the company’s internal projects.
No portion of extra investments should be utilized for financing a project.
Internal investment being the only option, the assumption is that the company is using its full potential to use its income from the other projects to fund a new one.
In case the dividend is distributed, it should be in a way that no extra income is retained after the distribution.
Constant Cost of Capital and Internal Returns
According to Walter’s model, the internal rate of return and cost of capital must remain constant in the entire lifecycle of a project. This means that the returns and cost of a project do not change with the change in other variables of the project.
Constant EPS and DIV
In Walter’s model, the EPS and dividend per share (DIV) do not change in the project’s lifecycle.
Although RPS and DIV can be adjusted before the project’s starting, once it is determined, they may not be changed in the project’s lifecycle.
As dividend is paid completely, the value of dividend payouts should remain the same throughout the entire project.
Infinite Time
Walter’s model considers projects that will run forever. This means that there is no question of a short and long time for evaluation the valuation of a firm. It is improbable to construct a project with a limited timeframe that would suit Walter’s model’s attributes completely if it is not infinite.
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