Question 4 (b)
Six differences between Gordon's and Walter's dividend models
6 marks
- Time to write
- About 12 minutes
Question
Question 4 (b) · 6 marksHow is Gordon's model different from Walter's model of dividends? Explain any six points on which they differ.
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- any sixThe paper asks for any 6, and this is one of them. Only 6 are marked: a further earns nothing.
- differSet the differences out in a table, basis by basis, not as two separate essays.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Six points of difference, one mark each 6 marks 10 min
- Check: every ask answered, key terms underlined 1 min
Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Both models hold that dividend policy is relevant to the value of the share, and both assume an all-equity firm that finances investment only from retained earnings, with constant r and ke and a perpetual life. They differ as follows:
| # | Point of difference | Walter's model | Gordon's model |
|---|---|---|---|
| 1 | Formula | P = [D + (r ÷ ke)(E − D)] ÷ ke | P = E(1 − b) ÷ (ke − br) |
| 2 | Basis of valuation | Value of the dividend plus the present value of the return earned on retained earnings | Present value of an infinite stream of dividends growing at a constant rate |
| 3 | Growth | No explicit growth rate | Growth is explicit: g = br, constant because b and r are constant |
| 4 | Condition required | No restriction linking ke and growth; it assumes that earnings and dividends do not change while the value is determined | ke must exceed the growth rate br |
| 5 | Treatment of risk | Risk is not considered; the value depends only on r compared with ke | Investors are risk averse and value current dividends more than uncertain future gains ("bird in hand") |
| 6 | When r = ke | Dividend policy is irrelevant; the price is the same at every payout | In Gordon's revised (bird-in-hand) model dividends still matter: investors put a premium on certain returns and the discount rate varies with the retention rate |
Conclusion. Walter's model makes the dividend decision depend entirely on the firm's return on investment compared with its cost of capital; Gordon's model adds growth and investors' risk aversion, so it argues for paying dividends even in cases where Walter's model is indifferent.
Where the 6 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Six points of difference, one mark each | 6 |
| Total | 6 |
Report a problemopens an email to admin@getkunji.com with the question ID7357-Q4balready filled in.