Financing Expansion via Pecking Order Theory

XYZ Corporation is a mid-sized firm looking to expand its operations. The management team is currently debating the most appropriate method to finance this expansion while considering their existing capital structure and future strategies. According to the pecking order theory, firms prefer internal financing over external financing, and within external financing, they favor debt over equity.

Given the team’s analysis, they have identified the following financing scenarios:

• Scenario 1: Utilize retained earnings to fund the expansion.
• Scenario 2: Issue bonds to raise the capital needed.
• Scenario 3: Issue new equity shares to finance the project.

Based on the pecking order theory, which financing scenario is XYZ Corporation most likely to choose for their expansion?