Suppose a firm Gamma Precisions makes more investment than another firm Fatty Food, whose payout ratio is usually 60%. Both firms enjoy a healthy return on equity of 20% constantly. Assuming that the predictions of the pecking order theory hold, answer the following questions.
a) What can we say about the payout ratio of Gamma Precisions? Explain why by focussing on the role of asymmetric information.
b) The debt-equity ratio of Gamma Precisions is currently 0.1, while that of Fatty Food is 0.2. If both firms are going to make an unusually large investment, how are they going to finance the investment? Explain.