The pecking order theory identifies two rules.The first rule is to
A)issue convertible debt prior to straight debt to save funds.
B)use short-term debt to its maximum available limit prior to issuing long-term debt.
C)issue new equity first in order to retain internal funds and avoid interest costs.
D)issue new debt prior to new equity.
E)use internal financing prior to external financing.

Question

Quizplus · Accepted Answer

The pecking order theory suggests that firms prefer to use internal financing (such as retained earnings) before seeking external financing (such as issuing new equity or debt). This is because internal financing does not come with any interest costs or dilution of ownership, and external financing can signal to investors that the firm has a lack of profitable investment opportunities. Therefore, the best choice is E, which states that firms should use internal financing prior to external financing. The other choices are not consistent with the pecking order theory.

The Pecking Order Theory Identifies Two Rules