Capital Structure Decisions and Pecking Order Theory

In the context of Pecking Order Theory, companies prioritize their sources of financing according to the principle of least effort, or from the least risky to the most risky. This approach implies that firms prefer internal financing over external financing, and, if external financing is necessary, they will opt for debt over equity due to the higher costs and informational asymmetries associated with issuing new equity.

Consider a hypothetical firm, Alpha Corp, which is currently evaluating its financing options to support a new investment project. Alpha Corp has sufficient retained earnings, but it is contemplating whether to use these retained earnings or to issue new debt. The firm’s management is concerned about the signaling effects of issuing new equity and potential dilution of existing shareholders’ value. Which of the following statements best reflects the implications of Pecking Order Theory for Alpha Corp's financing decision?