User Account

All Pages

Capital Rationing, Finance, Other Engineering

Assignment Help:
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.

Why capital rationing

Capital rationing may arise due to external factors or internal constraints imposed by the management. Thus there are two types of capital rationing:

• External capital rationing

• Internal capital rationing.

External capital rationing

External capital rationing mainly occurs on account of the imperfection in capital markets. Imperfections may be caused by deficiencies in market information, or by frigidities of attitude that hamper the free flow of capital. For example, supreme electronics ltd is a closely held company; it borrows from the financial institutions as much as it can. It still has investment opportunities, which can be financed by issuing equity capital. But it doesn’t issue shares; the owner-managers do not approve the idea of the public issue of shares because of the fear of losing control of the business. Consider another case. Tan India wattle extracts ltd. Proposes to set up a plant for manufacturing wattle extract. There is expected to be tremendous demand for wattle extract and therefore the proposed project is likely to be highly profitable. The respective investors however, are not convinced of the prospects of the project. For the company, therefore, the capital markets are non-existent. The NPV rule will not work if shareholders do not have access to the capital markets. Imperfections in capital markets alone do not invalidate use of the NPV rule. In reality, we will have very few situations where capital markets do not exist shareholders.

Internal capital rationing

Internal capital rationing is caused by self-imposed restrictions by the management. Various types of constraints may be imposed. For example, it may be decided not to obtain additional funds by incurring debt. This may be a part of the firm’s conservative financial policy. Management may fix an arbitrary limit to the amount of funds to be invested by the divisional mangers. Sometimes management may resort to capital rationing by requiring minimum rate of return higher than the cost of capital whatever may be the type of restrictions, the implication is that some of the predictable projects will have to be foregone because of the lack of funds. However, the NPV rule will work since shareholders can borrow or lend in the capital markets.

It is quite difficult sometimes to justify the internal capital rationing. But generally it is used as a means of financial control in a divisional set-up the divisional managers may overstate their investment requirements. One watt o forcing them to carefully assess their investment opportunities and set priorities is to put upper limits to their capital expenditures. Similarly, a company may put investment limits if it finds itself incapable of coping with the strains and organizational problems of a fast growth.

Related Discussions:- Capital Rationing, Finance

#titleMetrics.., Suppose you are managing a software-development project fo...

Suppose you are managing a software-development project for which reliability is a major concern. A continual stream of anomalies is discovered in the software during the testing p

Parabola tangent method, answer

answer

Request for quote, I need the following corporate finance problems complete...

I need the following corporate finance problems completed in an excel spreadsheet. How much would this cost? 1) An investment project requires a net investment of $100,000. The pr

Local attraction, how can we find local attraction correction?

how can we find local attraction correction?

Building economics, with sketches,describe single upper flows

with sketches,describe single upper flows

Aeroengine - linear blade cascade, A blade cascade is a row of evenly space...

A blade cascade is a row of evenly space yp dentical blades. Approximates to a turbomachinery rotor or stator if the radius the annulus is large compared with the bl the annulus is

General, why should an aircraft maintenance technician be familiar with wel...

why should an aircraft maintenance technician be familiar with weld nomenclature

Propeller shafts, PROPELLER SHAFTS Most modern engines, both reciprocat...

PROPELLER SHAFTS Most modern engines, both reciprocating and turbine, have flanged propeller shafts. Some of these flanges have integral internally threaded bushings that fit

Company Acquisition and Takeover vs acquisition , Company Acquisition, Take...

Company Acquisition, Takeover vs acquisition and holding copany A fundamental characteristic of merger (either through absorption or consolidation) is that the acquiring or amalg

flow solver, Flow Solver The flow solver of FP utilises data produced ...

Flow Solver The flow solver of FP utilises data produced by the grid generator, together with data read from an input file named FLOW.DAT, and proceeds to calculate the solutio

Write Your Message!

Captcha
Order Assignment

Featured Services

Order Now

Popular Subjects

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

Submit Assignment

Academics

Major Subjects

Majors

Get In Touch

whatsapp: +91-977-207-8620

Phone: +91-977-207-8620

Email: [email protected]

TERMS & POLICIES

HELP & SUPPORT

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd