With the background ideas of using the cheapest source first and the impact of asymmetric information,the Pecking Order Hypothesis predicts which of the following?
A)Firms prefer internal financing second to external financing.
B)If external financing is required,firms should first seek equity financing.
C)If external financing is required,firms will choose to issue the riskiest security first,starting with debt financing and using equity as a last resort.
D)If external financing is required,firms will choose to issue the safest or cheapest security first,starting with debt financing and using equity as a last resort.

Question

Quizplus · Accepted Answer

The Pecking Order Hypothesis suggests that firms will prefer internal financing first, followed by the safest/cheapest external financing option available. This means that firms will choose debt financing before equity financing, and will seek to issue the safest or cheapest security first. This is because of the impact of asymmetric information, which means that firms may be penalized for issuing riskier securities due to the uncertainty surrounding their true value. Therefore, option D - "If external financing is required, firms will choose to issue the safest or cheapest security first, starting with debt financing and using equity as a last resort" - is the correct answer.

With the Background Ideas of Using the Cheapest Source First