According to the pecking-order theory,managers will often choose to finance with:
A) new equity rather than debt, due to bankruptcy costs.
B) debt rather than new equity, to avoid a fall in the share price.
C) debt rather than retained earnings, to lower the WACC.
D) new equity rather than debt, to strengthen EPS.

Question

Quizplus · Accepted Answer

According to the pecking-order theory, managers prefer to finance with debt over new equity because they believe that issuing new equity will lead to a decline in the share price. This is because issuing new equity signals that the company believes its current projects are not sufficiently profitable to cover the cost of capital through retained earnings, which can lead investors to view the company less favorably. On the other hand, the cost of debt financing is generally lower than the cost of equity financing, and it does not carry the same signal of poor investment opportunities.

According to the Pecking-Order Theory,managers Will Often Choose to Finance