Capital Rationing is a critical financial strategy used by companies to manage investment decisions when funds are scarce. It involves selecting the most profitable projects within the constraints of available capital. Techniques like NPV, IRR, and Profitability Index are employed to prioritize investments, ensuring the best use of limited resources for corporate growth and strategic financial management.
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Capital Rationing is a strategic financial management tool used by companies to select the most profitable projects within limited capital
Self-imposed
Internal Capital Rationing is self-imposed by a company's management to maintain financial discipline or avoid over-leveraging
Reasons
Internal Capital Rationing is often used to manage risk and align investments with corporate strategy
Market Imperfections
External Capital Rationing occurs due to market imperfections, such as credit rationing by banks
Reasons
External Capital Rationing can be caused by factors such as stringent lending conditions or elevated interest rates
Capital Rationing plays a significant role in the investment decision-making process within the field of Corporate Finance
Net Present Value (NPV)
In a capital rationing scenario, financial evaluation methods such as NPV are adjusted to account for limited budget
Internal Rate of Return (IRR)
IRR is another method used to assess and prioritize investment projects in a capital rationing scenario
Ranking
Projects are ranked based on financial metrics such as Profitability Index or Present Value Ratio
Linear Programming and Integer Programming Models
More sophisticated techniques such as linear programming and integer programming can also be used for project selection in capital rationing
The PI is a crucial calculation in Capital Rationing, used to rank projects based on their expected returns
The Capital Rationing process begins with identifying and evaluating potential investment projects
Projects are ranked based on their profitability indices, and capital is allocated to the highest ranking projects first
Soft Capital Rationing
Soft Capital Rationing is self-imposed by a company's management, while Hard Capital Rationing is caused by external market factors
Impact on Decision-Making
Both types of Capital Rationing require careful decision-making to ensure effective use of limited capital resources
Capital Rationing plays a crucial role in determining a company's growth trajectory and strategic financial management
While Capital Rationing can lead to better risk management and resource allocation, it may also limit a company's ability to seize long-term growth opportunities
Capital Rationing is a fundamental concept in Business Studies, teaching students the importance of strategic allocation of limited capital resources
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Definition of Capital Rationing
Strategic tool for selecting profitable projects under fund scarcity.
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Internal Capital Rationing Purpose
Self-imposed to maintain financial discipline or prevent over-leveraging.
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Causes of External Capital Rationing
Market imperfections like credit rationing by banks limiting fund access.
