Which of the following are correct according to pecking-order theory?
I.Firms stockpile internally-generated cash.
II.There is an inverse relationship between a firm's profit level and its debt level.
III.Firms avoid external debt at all costs.
IV.A firm's capital structure is dictated by its need for external financing.
A)I and III only
B)II and IV only
C)I, III, and IV only
D)I, II, and IV only
E)I, II, III, and IV

Question

Quizplus · Accepted Answer

Pecking-order theory suggests that firms prefer to finance new projects using internal funds (I), and if additional funds are needed, they will issue debt before issuing equity. This implies an inverse relationship between profitability and debt level (II), as more profitable firms will need less external financing. The theory does not suggest that firms avoid external debt at all costs (III is incorrect), but rather that they have a preference order for financing sources. It also implies that a firm's capital structure is influenced by its need for external financing (IV), as firms with insufficient internal funds will turn to debt or equity markets.

Which of the Following Are Correct According to Pecking-Order Theory