Allison's requires $180,000 to fund a new project next year.The firm expects to earn excess cash of $68,000 this year after all expenses,taxes,and dividends are paid.The firm can borrow up to $150,000 at 6.5 percent interest for up to ten years or,it can issue up to 25,000 new shares of stock that will have an estimated value of $35 a share at the end of this year.According to the pecking-order theory,how much will the firm raise in new equity capital to fund this project?
A)$0
B)$30,000
C)$112,000
D)$90,000
E)$180,000

Question

Quizplus · Accepted Answer

According to the pecking-order theory, firms prefer to finance projects first with internal funds (retained earnings), then with debt, and finally with issuing new equity as a last resort. Since Allison's can cover part of the project with its excess cash of $68,000 and can borrow up to $150,000, it will not need to raise new equity capital if these sources are sufficient to cover the project cost of $180,000.

Allison's Requires $180,000 to Fund a New Project Next Year