Consider the Additional Funds Needed AFN equation what happe

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

Solution

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