The pecking order theory of capital structure predicts that
A)if two firms are equally profitable, the more rapidly growing firm will end up borrowing more, other things equal.
B)firms prefer equity to debt financing.
C)firms prefer financing by debt versus internally generated cash.
D)high-risk firms will end up borrowing more.

Question

Quizplus · Accepted Answer

The pecking order theory suggests that firms prefer internal financing first, then debt financing, and finally equity financing. Within debt financing, firms prefer lower-risk debt over higher-risk debt, which means that high-risk firms will end up with less debt financing. Therefore, option D is incorrect. Option B is also incorrect as the theory says that firms prefer debt financing over equity financing. Option C is incorrect as the theory suggests the opposite, that firms prefer internal financing over debt financing. So, option A is the correct answer as the theory predicts that if two firms are equally profitable, the more rapidly growing firm will end up borrowing more, other things equal.

The Pecking Order Theory of Capital Structure Predicts That