Which of the following statements is correct?
A)The firm should finance using retained earnings, then debt, and, finally common equity.
B)The firm should finance using debt, then retained earnings, and, finally common equity.
C)The firm should finance using common equity, then retained earnings, and finally debt.
D)The firm should finance using retained earnings, then preferred shares, then debt and finally common equity.

Question

Quizplus · Accepted Answer

The correct statement is A, which outlines the pecking order theory. This theory suggests that companies prioritize their sources of financing (from internal financing to equity) according to the principle of least effort, or least resistance, starting with retained earnings, then debt, and finally equity as the last resort. This is because internal financing is generally considered the cheapest and least risky source of capital, followed by debt, and then equity, which is often the most expensive due to the higher risk for investors.

Which of the Following Statements Is Correct