Question

The Pecking Order view on capital structure:

a. Argues that firm's first choice for capital is new equity due to the fact that dividends are not contractually required.
b. Argues that the firm's first choice for capital is new debt as interest payments are tax-deductible.
c. Argues that a firm's first choice for capital is retained earnings as there is no informational cost associated with using retained earnings.
d. Argues that firms are indifferent between new equity, debt and retained earnings as sources of capital.

Answer 1

c. Argues that a firm's first choice for capital is retained earnings as there is no informational cost associated with using retained earnings.

Step-by-step explanation:

The Pecking order theory states that a business should first of all seek for internal funds (retained earnings) as a first choice of capital.

When internal funds are depleted, it can now look to debt as a source of finance.

In turn when debt options have been exhausted the last resort is to look for funding from equity.

So the Pecking order argues that a firm's first choice for capital is retained earnings as there is no informational cost associated with using retained earnings.