Question

The pecking order explanation of capital structure states that a hierarchy of financing exists for firms, in which retained earnings are employed first, followed by debt financing and finally by external equity financing.A. TrueB. False

Answer 1

False

Step-by-step explanation:

The pecking order theory states that managers display the following preference of source to fund investment opportunities; first, through the company's retained earnings, followed by debt, and choosin equity financing as a last resort.

In the context of pecking order theory, retained earnings financing (internal financing) comes directly from the company and minimizes information asymmetry. As opposed to external financing, such as debt or equity financing where the company must incur fees to obtain external financing, internal financing is the cheapest and most convenient source of financing.

Answer 2

True

Step-by-step explanation:

The pecking order theory is used to describe the hierarchy and manner a company selects its source in realm practical terms. According to the theory, a company would select source of finance in this order:

Retained earnings,

Straight debt

Convertible debts

Preference shares

Ordinary shares(equity)

In a nutshell, the choice of finance is made from the least expensive to the most expensive.