Question

Which of the following best defines the Pecking Order Theory.

Select one:

a. The theory states that capital structure is based on a trade-off between tax savings and distress costs of debt.

b. The theory states that firms prefer to use equity rather than debt and reduce the risk of financial distress.

c. The theory states that an optimal capital structure cannot be determined because firms make use of funds which are easily accessible.

d. The theory stating that firms prefer to issue debt rather than equity if internal finance is insufficient.

Answer 1

According to Pecking order Theory, first preference is given to internal financing and if the internal financing is insufficient, financing through debt is preferred than equity. In short for financing a project first internal financing is considered, then debt financing and at last through equity financing.

Based on the above discussion, option (d) is the correct answer i.e. "The theory stating that firms prefer to issue debt rather than equity if internal finance is insufficient."