Question

Hens Inc. has a total debt ratio of 60%, which is slightly above the industry average total debt ratio of 55% . Hens Inc. decides to follow only pecking order theory when deciding how to raise capital to pay for new projects, so they should

Multiple Choice

• use equity to get closer to the optimal capital structure then issue additional debt if necessary.

• use internal financing prior to external financing.

• use short-term debt to its maximum available limit prior to issuing long-term debt.

• issue convertible debt and buy assets to reduce their total debt ratio in order to be closer to the optimal level of debt.

• issue equity while maintainng reserve borrowing capacity.

Answer 1

As the debt ratio of the company is not very low as compared to the industry average, it is not a problem. In the pecking order theory, the company should first prefer using internal source of finance and then look at issuing external debt and equity.

As Hens Inc. decides to follow only pecking order theory when deciding how to raise capital to pay for new projects, so they should-

B) Use internal financing prior to external financing.

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