Capital Rationing Capital Rationing

Capital rationing refers to a situation where the firm is constrained for external, or self-imposed, reasons to obtain necessary funds to invest in all investment projects with positive NPV. Under capital rationing, the management has not simply to determine the profitable investment opportunities, but it has also to decide to obtain that combination of the profitable projects which yields highest NPV within the available funds.

Lecture Prepared By Dr. Narendra Singh Bohra Assistant Professor Faculty of Management GEU

External Capital Rationing Types of Capital Rationing

1. 2.

External Capital Rationing Internal Capital Rationing

Due to imperfection of capital market. Imperfection may because of

Deficiency in market information Rigidity of management attitude that hamper the free cash flow of capital

Internal Capital Rationing

Self imposed restriction by management. like
Obtaining funds from a specified source. Fix the limits on allocation of funds.

Use of PI in Capital Rationing

The NPV rule is modified while choosing among projects under capital constraint. The objective should be to maximise NPV per rupee of capital rather than to maximise NPV. Projects should be ranked by their profitability index, and toptop-ranked projects should be undertaken until funds are exhausted

Use of PI in Capital Rationing

The Profitability Index does not always work. It fails in two situations: MultiMulti-period capital constraints. Project indivisibility