Limitations Homework Help

Limitations

The Walter’s model, one of the earliest theoretical models, explains the relationship between dividend policy and value of the firm under certain simplified assumptions. Some of the assumptions do not stand critical evaluation. In the first place, the Walter’s model assumes that the firm’s investments are financed exclusively by retained earnings; no external financing is used. The model would be only applicable to all-equity firms. Secondly, the model assumes that is constant. This is not a realistic assumption because when increased investments are made by the firm, r also changes. Finally, as regards the assumption of constant, k, the risk complexion of the firm has a direct bearing on it. By assuming a constant k, Walter’s model ignores the effect of risk on the value of the firm.

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