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Yellow Leaf Bookstore just finished calculating its DFN to be $450,000. What can the company do to reduce its DFN?

Rationale

Decreasing its dividend payout ratio will help Yellow Leaf Bookstore reduce its DFN.

By decreasing the dividend payout ratio, the bookstore retains more earnings, which can be reinvested into the business, thus reducing the need for external financing and lowering its Debt Financing Need (DFN).

A (Decrease its plowback ratio) YOUR ANSWER

The plowback ratio indicates the portion of earnings retained in the business. Decreasing the plowback ratio means that more earnings are distributed as dividends, which would actually increase the DFN rather than decrease it, contrary to the goal.

B (Decrease its dividend payout ratio) CORRECT

This option directly addresses the DFN issue. By reducing the dividend payout ratio, the bookstore retains a larger share of its earnings, which can be used for reinvestment or to pay down debt. This strategy effectively lowers the reliance on external financing, thus reducing the DFN.

C (Increase its average collection period) YOUR ANSWER

Increasing the average collection period means that the bookstore takes longer to collect receivables, which can lead to cash flow issues. This would likely increase the DFN, as the company may need to seek additional financing to maintain operations, contradicting the goal of reduction.

D (Increase its sales growth) YOUR ANSWER

While increasing sales growth can improve overall profitability, it does not directly reduce the DFN unless it translates into better cash retention or lower reliance on debt. Higher sales could lead to increased operational costs or the need for additional financing to support the growth, which may not alleviate the DFN.

Conclusion

To effectively reduce its DFN, Yellow Leaf Bookstore should focus on decreasing its dividend payout ratio, allowing for more retained earnings to fund operations and reduce dependency on external financing. The other options either fail to address the DFN directly or could inadvertently increase it, highlighting the importance of strategic financial management in maintaining fiscal health.

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