土豆妮

According to pecking order theory, which of the following lists most accurately orders financing preferences from most to least preferred?

A) Debt financing, retained earnings, and raising external equity.

B) Retained earnings, raising external equity, and debt financing.

C) Retained earnings, debt financing, and raising external equity.

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Financing choices under pecking order theory follow a hierarchy based on visibility to investors with internally generated capital being the most preferred, debt being the next best choice, and external equity being the least preferred financing option.

土豆妮

Which of the following statements regarding how different capital structure theories impact managers’ capital structure decisions is most accurate? According to:

A) the static trade-off theory, debt will not be used if a company is in a high corporate tax bracket.

B) MM’s propositions (assuming no taxes), companies have an optimal level of debt financing.

C) pecking order theory, issuing new debt is preferable to issuing new equity.

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Pecking order theory is related to the signals management sends to investors through its financing choices. Financing choices follow a hierarchy based on visibility to investors with internally generated funds being the least visible and most preferred, and issuing new equity as the most visible and least preferred. Under static trade-off theory, higher tax brackets result in greater tax savings from using debt financing. Under MM’s propositions (assuming no taxes), capital structure is irrelevant and there is no optimal level of debt financing.

土豆妮

Schwarzwald Industries recently issued new equity to help fund a new capital project. What type of signal is Schwarzwald’s choice of financing sending to investors about the future prospects of the firm under the information asymmetry signaling theory and pecking order theory respectively?

A) Negative signal under both theories.

B) Positive signal under both theories.

C) Positive signal under only one theory.

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Signaling theory results from asymmetric information, which refers to the fact that managers have more information about a company’s future prospects than the firm’s owners and creditors. Since managers are reluctant to sell new stock if they think the stock is undervalued, but very willing to sell stock if they think the stock is overvalued, selling stock sends a negative signal about a firm’s future prospects. Pecking order theory, which is related to signaling theory, suggests that managers choose methods of financing based on the visibility of signals they send. Raising equity is the least preferred method of financing under pecking order theory, and it sends a negative signal.