Question

6. Factors that affect the AFN equation Several factors affect a firm's need for external funds. Evaluate the effect of each following factor and place a check next to each factor that is likely to increase a firm's need for external capital-that is, its AFN (additional funds needed). Check all that apply. The firm improves its production system and increases its profit margin. The firm switches its supplier for the majority of its raw materials. The new supplier offers less favorable credit terms and thus reduces the trade credit available to the firm, resulting in a reduction in accounts payable. The firm increases its dividend payout ratio. BurnButter First Aid Supply has seen its profit margin eroded by increased competition over the last year, but its sales have remained steady. Assuming everything else is held constant, will this affect the firm's AFN? O Yes, the decrease in profit margin will affect the firm's AFN even though its sales have remained constant. O No, the firm's AFN will not be affected, because the firm's sales have remained constant.

Answer 1

1: Options 2 And 3

Increase in profit margin I will not increase the external funds needed because there will be greater retained earnings. Reduction in accounts payable implies reduction in working capital finance and this will increase external funds needed. Increasing dividend payout ratio implies lesser retained earnings which will again increase external funds needed.

2: Yes

Decrease in profit margin implies lesser retained earnings which will require greater external funds needed.