Final answer:
It is true that when a firm increases its dividend payout ratio, its Additional Funds Needed (AFN) is likely to increase if other factors remain unchanged, as more cash is distributed to shareholders instead of being used for internal growth.
Step-by-step explanation:
If everything else remains unchanged, when a firm increases its dividend payout ratio, its Additional Funds Needed (AFN) is more likely to increase as well. This statement is true. When a company decides to pay out a higher percentage of its earnings as dividends to shareholders, it is distributing cash that could have been retained within the company for growth or investment purposes. Consequently, if the firm still aims to pursue new investments or expand its operations, it will need to seek external financing, thereby increasing its AFN.
The dividend payout ratio is the proportion of earnings paid out as dividends to shareholders. When this ratio increases, the firm retains less profit for reinvestment. Therefore, if the firm has plans for expansion or any capital expenditures, it will have less internal funding to cover these costs. This leads to a higher need for external financing, whether via debt or new equity - reflected in an increased AFN.
The AFN formula considers the dividend payout ratio as one of its variables. An increased dividend payout means there's less retained earnings contributing to the firm's internal equity growth, thus potentially increasing the AFN if the company has profitable investment opportunities that it wants to pursue and for which the internally generated funds are insufficient.