This leads to the following pecking order in the

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ing adverse signals to the stock market. Moreover, even debt issues might create information problems if the probability of default is significant, since a pessimistic manager will issue debt just before bad news get out. This leads to the following pecking order in the financing decision: 1. Internal cash flow 2. Issue debt 3. Issue equity The pecking order theory states that internal financing is preferred over external financing, and if external finance is required, firms should issue debt first and equity as a last resort. Moreover, the pecking order seems to explain why profitable firms have low debt ratios: This happens not because they have low target debt ratios, but because they do not need to obtain external financing. Thus, unlike the trade-off theory the pecking order theory is capable of explaining differences in capital structures within industries. 8.10 A final word on Weighted Average Cost of Capital All variables in the weighted average cost of capital (WACC) formula refer to the firm as a w...
View Full Document

Ask a homework question - tutors are online