Question

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 increases its dividend payout ratio.

The firm previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity.

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.

Dividends to common shareholders are paid out of after-tax earnings. Do these payouts affect a firm’s AFN?

No, dividends do not affect a firm’s AFN, because they are paid out of after-tax earnings.

Yes, dividends still affect a firm’s AFN even though they are paid out of after-tax earnings.

Answer 1

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.

1) The firm increases its dividend payout ratio. - yes - this will reduce the earnings and likely to cause the company to borrow from outside

2) The firm previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity - No- This will not affect its need for external funds

3) 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. - Yes - this will reduce Working capital and cause the company to increase short term borrowings from external source

4) Dividends to common shareholders are paid out of after-tax earnings. Do these payouts affect a firm’s AFN? -

Yes, dividends still affect a firm’s AFN even though they are paid out of after-tax earnings.

If less dividends are paid to common shareholders, more of the internal funds are accrued which reduces its need to borrow from outside the funds required for its operations