Question 6.12: Are retained profits a free source of finance for the busine...

It is tempting to think that retained profits are a cost-free source of funds for a business. However, this is not the case. If profits are reinvested rather than distributed in cash to shareholders, those shareholders cannot reinvest this cash in other forms of investment. They will therefore expect a rate of return from the profits reinvested which is equivalent to what they would receive if the funds had been invested in another opportunity with the same level of risk.