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Which of the following is/are correct? The pecking-order theory states that firms prefer to issue equity...

Which of the following is/are correct?

  1. The pecking-order theory states that firms prefer to issue equity rather than debt if internal financing is insufficient.

II. The pecking-order theory suggests that profitable firms use more debt.

  1. The trade-off theory of capital structure implies that there is an optimal level of debt for firms, given the benefits of tax shields and the costs of financial distress.
  1. I only
  2. I and II only
  3. III only
  4. all of the above
  5. none of the above
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Answer #1

Option C is correct.

Pecking Theory states that a firm uses the internal funds i.e. Retained Earnings first of all and then Debt and then Equity is the last resort and profitable firms uses retained earnings. The trade-off theory of capital structure implies that there is an optimal level of debt for firms, given the benefits of tax shields and the costs of financial distress.

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