CAPITAL RATIONING - Introduction, Meaning, Types, Advantages, Disadvantages and Problems

This ppt contains CAPITAL RATIONING - Introduction, Meaning, Types, Advantages, Disadvantages and Problems

1. CAPITAL RATIONING Introduction, Meaning, Types, Adv., Disadv . and Problems Sundar B. N. Assistant Professor

2. CAPITAL RATIONING - INTRODUCTION Capital Rationing is a situation, when there is some ceiling on the availability of funds. This may be externally imposed , e.g. the financial institutions fix a limit of Rs . 10 lacs that can be given for a project or projects, or it may be internally imposed also, e.g. the company has decided to utilize only the internally available funds and the availability of funds is Rs . 5 lac. When capital is rationed, the NPV rule needs modification. This is because, in the absence of Capital Rationing, all the proposals, giving a positive NPV are acceptable without any limit. When a ceiling of funds is imposed, this cannot be done because we may not be in a position to accept all the acceptable proposals if initial investment amount exceeds the ceiling amount. 2

3. Meaning of Capital Budgeting Capital rationing is a technique of selecting the projects that maximize the firm’s value when the capital infusion is restricted . Capital rationing is the process of putting restrictions on the projects that can be undertaken by the company or the capital that can be invested by the company. This aims in choosing only the most profitable investments for the capital investment decision. This can be accomplished by putting restrictive limits on the budget or selecting a higher cost of capital as the hurdle rate for all the projects under consideration. 3

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6. Example 1 6 Assume that we have the following list of projects with the below-mentioned cash outflow and their evaluation results based on IRR, NPV, and PI along with their respective rankings. The capital ceiling for investment is, say, 650. Capital Budgeting Calculation

7. Projects Selection 7 In the table, if we select based on individual method, we will arrive at the following result: The results are quite obvious and we will go with B, F, E, and D to achieve a maximum value of 760 .

8. Example 2 8 If the budget ceiling for initial cash outflows during the present period is $65,000 and the proposals are independent select the combination of projects which maximises value Capital Budgeting Calculation

9. Projects Selection 9

10. Assignment 10

11. Reference Fenner , W. G. (1978). Fundamentals of financial management: James C. Van Horne, Prentice-Hall, 1977, Price:[UK pound] 11.95.  Engineering and Process Economics ,  3 (3), 221-222. https :// efinancemanagement.com/investment-decisions/capital-rationing https://efinancemanagement.com/investment-decisions/capital-rationing-its-assumptions-advantages-and-disadvantages 11