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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.
3. Which of the following statements is CORRECT?
a. When we use the AFN equation, we assume that the ratios of assets
and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a
stable, predictable manner.
b. When fixed assets are added in large, discrete units as a company
grows, the assumption of constant ratios is more appropriate than if
assets are relatively small and can be added in small increments as sales
grow.
c. Firms whose fixed assets are “lumpy” frequently have excess
capacity, and this should be accounted for in the financial forecasting
process.
d. For a firm that uses lumpy assets, it is impossible to have small
increases in sales without expanding fixed assets.