Which of the following statements is correct? a. The sustainable growth rate is
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Question
Which of the following statements is correct? a. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero b. If a firm's assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm's AFN to be negative c. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm's actual AFN must, mathematically, exceed the previously calculated AFN d. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero-dividend payout ratio e. Dividend policy does not affect the requirement for external funds based on the AFN equation
Explanation / Answer
Statement A is correct.
By AFN we understand Additional funds needed and is a common concept looked by the businesses when planning to expand its business operations. When planning to increase operations, any organization would need more assets and to plan the same, some provision must be made to accomodate the change.
It is calculated as: Projected increase in assets - spontaneous increase in liability - any increase in retained earnings
The equation would look like:
AFN = (A*S0)*(S1-S0)-(L*S0)*(S1-S0)-MS1(RR)
A= Asset tied directly to sales
S0= Previous year sales
S1= Projected Sales for next year
L= Liabilities linked to sales
M= Profit Margin
S1= Projected net income
RR= Retention Ration from nt income
The mathematical formulas used to determine AFN are based on showing how liabilities will grow relative to new assets and sales when a project is undertaken and can be used as tools to determine whether a project or operational expansion is worthwhile.
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