presentation in finanace

1. Pecking Order
Theory
Presented by:Samah Mahmoud Hassan

2. Agenda
• Introduction
• Components of pecking
Order Theory
• Pecking Order Theory
• Factors
• Example
• Solution
• Conclusion
• Reference
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3. Introduction
• The Pecking Order theory
suggests that there’s an
order of preference for the
firm of capital sources when
funding is needed
• This theory made popular
by Stewart Myers and
Nicolas Majluf in 1984,The
theory states that managers
follow a hierarchy when
considering sources of
financing
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4. Last year

5. Components Of Pecking Order
Theory
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• The firm will seek to satisfy funding
needs in the following order:
• 1-Internal Funds
• 2-External Funds:
• a-Debt
• B-Equity

6. Pecking Order Theory
6 Annual Review October 9, 2023
• The Pecking Order theory
suggests that the firm will first
use internal funds. More
profitable companies will
therefore have less use of
external sources of capital and
may have lower debt-equity
ratios

7. “
- If internal funds are exhausted, then the firm
will issue debt until it has reached its debt
capacity.
- Only at this point will firms issue new equity.
- This theory also suggests that there is no
target debt-equity mix of firm

8. Factors
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• There are three factors that the pecking
order theory is based on and that must be
considered by firms when raising capital.
• Internal funds are cheapest to use and
require no private information release
• Debt financing is cheaper than equity
financing
• Managers tend to know more about the
future performance of the firm than
lenders and investors

9. Example
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• Suppose ABC company is looking to raise$ 10
million for project. The company’s stock price
is currently trading at $53-77.Three options are
available for ABC company:-
• 1- Finance the project directly through retained
earnings.
• 2-One year debt financing with an interest rate
of9% although management believes that 7%
is the fair rate
• 3-Issuance of equity that will underprice
current stock price by 7%

10. Solution
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• Option1: if management finances the project directly through
retained earnings, the cost is $ 10 million
• Option2:If the management finances the project through
debt issuance, the one year debt would cost$10.9
million($10*1.09=$10.9)Thus financing the project via debt
issuance would yield a cost of $10.9 million.
• Option3:If management finances the project through equity
issuance, to raise $10 million, the company will need to sell
200,000
shares($53.77X0.93=$50),($10,000,000/$50=200,000
shares)
• The true value of the shares would be $10.75 million
($53.77X200,000 shares=$10.75 million).Therefore, the cost
would be $10.75 million

11. Advantages of Pecking Order
Theory
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Some of the major advantages of the pecking order
theory are as follows:
•First, it is a useful theory that guides in verifying how
information asymmetry affects the financing cost.
•It helps companies decide the optimal way to raise
funds for financing corporate strategies, such as a new
project.
•It shows how the company managers are eager to
maintain control of the firm.

12. Disadvantages of Pecking
Order Theory
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Some of the major disadvantages of the
pecking order theory are as follows:
•First, the theory focuses on a very limited
number of variables while determining the
effect on the cost of financing.
•It doesn’t provide any quantitative
estimate of the impact of information flow
on the cost of financing.
• Doesn’t consider financial fundraising
methods

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Limitations of Pecking Order
Theory
•Limited to a theory.
•Pecking order theory cannot make practical
applications because of its theoretical nature.
•Limits the types of funding.
•New types of funding cannot be included in the
theory.
•The very old theory has not been updated with
newer financial fundraising methods.
•No-Risk vs. Reward measure to include in the cost
of financing.

14. Conclusion
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• The capital structure is the particular combination of
debt and equity used by a company to finance its
overall operations & growth
• The pecking order theory states that a company
should prefer to finance itself first internally through
retained earnings…Finally, and as a last resort, a
company should finance itself through the issuing of
new equity
• This pecking order is important because it signals
to the public how the company is performing.
• The theory arises from information asymmetry and
explains why equity financing is the costliest and
should be the last resort for financing.

15. Reference
Pecking Order theory
(retrieved from https://corporatefinanceinstitute.com/resources/knowledge/finance/pecking-order-theory/)
Pecking order theory factors
(retrieved from https://slideplayer.com/amp/1474384/)
Pecking Order theory of capital structure
(retrieved by, Murray Z Frank Vidhan K Goyal)
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16. Thank you