Question

Consider the Additional Funds Needed (AFN) equation, what happens to AFN if the firm decreases their retention ratio?

AFN increases
		AFN stays the same
		AFN is not affected by profit margin
		its hard to say exactly
		AFN decreases

Answer 1

The AFN equation is below:

Actual funds needed=((A0/S0)*chnage in sales)--((L0/S0)*chnage in sales)-((M*Next year sales)*(1-payout))
Ao = current level of assets
S/So = percentage increase in sales i.e. change in sales divided by current sales
Lo = current level of liabilities
S1 = new level of sales
PM = profit margin
b = retention rate = 1 – payout rate

From the equation we can see that of there is decrease in rentention ratio then the AFN will decreases

it is option D