A company earns $5 per share; it is capitalized at a rate of 10% and has a rate of return on investments of 16%. According to Walter’s model what should be the price per share at 50% dividend pay out ratio?
Is this the optimum pay out ratio according to Walter?
(Moved to math to enable the equation editor)
Let E = earnings per share = $5.00
Let `k_e` = rate of capitalization = 10% = 0.10
Let r = rate of return = 16% = 0.16
Let DP = pay out ratio = 50% = 0.50
Let D = dividend per share
According to Walter's model:
`D = E*DP` and `P=(D+(r/k_e)(E-D))/k_e`
Substituting in what we know:
`D = (5)(0.5)=2.50`
Therefore, according to Walter's model, the price per share should be $65.
Also, according to Walter, when `rgtk_e` the optimum payout ratio is 0. Therefore, $65 is higher than the optimum price per share of $0. Essentially, this means that if the company keeps all of its earnings (no dividend), the shares will be worth the maximum market value.
Thanks very much sir.