Section A

BioGenix, a profitable biotechnology firm, needs to raise $20 million for clinical trials. According to the Pecking Order Theory of capital structure, which source of finance will BioGenix prioritize FIRST?

Answer options:

Issue of new ordinary shares

Issue of convertible bonds

Bank loan

Retained earnings

How to approach this question

Recall the hierarchy of the Pecking Order Theory: 1. Internal funds, 2. Debt, 3. Equity.

Full Answer

D.Retained earnings✓ Correct

The Pecking Order Theory suggests that companies prioritize their sources of financing based on the principle of least effort, lowest cost, and minimal information asymmetry. The order is: 1) Retained earnings (internal funds), 2) Straight debt, 3) Convertible debt, 4) New equity.

Common mistakes

Confusing the Pecking Order Theory with the Traditional View or Modigliani-Miller theories, which seek an optimal mix of debt and equity.

Question 9 All questions Question 11

Practice the full ACCA FM — Financial Management Practice Exam 1

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