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dit Viow Insert Format Tools Table VitalSource Home Arial Unicode....A-AA Styles 8. According to the pecking order theory proposed by Stewart Myers of MIT, which of the following are correct? L For financing needs, firms prefer to first tap internal sources such as retained profits and excess cash. IL. There is an inverse relationship between a firm's profit level and its debt level. Ml. Firms prefer to issue new equity rather than source external debt IV. A firm's capital structure is dictated by its need for external financing A. I and ill only B. It and only C, 1,11, and ony D. I, II, and IV only E. I, II, Ill, and IV F. None of the above. 19 1449 wordsC Focus

Explanation / Answer

According to pecking order theory proposed by Stewart Myers of MIT, which of the following are correct?

D. I, II, and IV only

The pecking order theory postulates that the cost of financing increases with asymmetric information.

Financing comes from three sources, internal funds, debt and new equity. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly raising equity as a "last resort".

Hence: internal financing is used first; when that is depleted, then debt is issued; and when it is no longer sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required. Thus, the form of debt a firm chooses can act as a signal of its need for external finance.

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