Given below are two statements:
Assertion (A): The extent of retained earnings influences the financing decision of a firm.
Reason (R): A firm does not require funds to the extent of re-invested retained earnings.
In the light of the above statements, choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both (A) and (R) are true and (R) is the correct explanation of (A).
Assertion (A): The extent of retained earnings influences the financing decision of a firm. — True. The financing decision settles how much finance is raised and from which source. Retained earnings are profits kept back in the business, and they are part of the shareholders’ funds. Their size affects this decision.
Reason (R): A firm does not require funds to the extent of re-invested retained earnings. — True. Profits that are re-invested already supply funds. So the firm needs that much less from other sources.
Why R explains A?
R says that re-invested profits meet part of the firm’s need for funds. Because this part is already met, the firm has less to raise through shares or debt. So the larger the retained earnings, the smaller the amount to be raised, and this changes the financing decision in A.
NCERT (2026-27 Edition): “Dividend Decision The third important decision that every financial manager has to take relates to the distribution of dividend. Dividend is that portion of profit which is distributed to shareholders. The decision involved here is how much of the profit earned by company (after paying tax) is to be distributed to the shareholders and how much of it should be retained in the business. While the dividend constitutes the current income re-investment as retained earning increases the firm’s future earning capacity. The extent of retained earnings also influences the financing decision of the firm. Since the firm does not require funds to the extent of re-invested retained earnings, the decision regarding dividend should be taken keeping in view the overall objective of maximising shareholder’s wealth.” |