Capital rationing refers to a situation where a firm is not in a position to invest in all profitable projects due to the constraints on availability of funds.
Capital Rationing – Meaning
Capital rationing refers to a
situation where a firm is not in a position to invest in all profitable
projects due to the constraints on availability of funds. We know that the
resources are always limited and the demand for them far exceeds their
availability, it is for this reason that the firm cannot take up all the
projects though profitable, and has to select the combination of proposals that
will yield the greatest profitability.
Capital rationing is a situation
where a firm has more investment proposals than it can finance. It may be
defined as “a situation where a constraint is placed on the total size of capital investment during a particular period”. In such an event the firm has to select combination of investment proposals that provide the highest net present value subject to the budget constraint for the period. Selecting of projects for this purpose will require the taking of the following steps:
1. Ranking of projects according to profitability index or internal’-rate of return.
2. Selecting projects in descending order of profitability until the budget figures are exhausted keeping in view the objective of maximizing the value of the firm.
Tags : Financial Management - Capital Budgeting – A Conceptual Framework
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