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

Water traetment, what are the different phosphates used in water treatment?...

what are the different phosphates used in water treatment?

Evaporation, 2-17 Given a wind speed of 5.0 m/s at 2 m above the ground and...

2-17 Given a wind speed of 5.0 m/s at 2 m above the ground and a roughness length of 0.8 cm, compute (a) the friction velocity, in centimeters per second, and (b) the wind speed, i

Alternative escape routes - means of escape, Alternative escape routes: ...

Alternative escape routes: Does everyone have access to the alternative routes or do some people have no choice about which way they go? Are all the escape routes

Roof bolt support performance, A certain coal mine has weak layer comprisin...

A certain coal mine has weak layer comprising of 10cm, 11cm, 9cm, 12cm, 15cm , and 19cm of inter laminated shales and mudstone. Design a full column resin bolt support system if th

The unity gain follower, The unity gain follower: The somewhat lengthy ...

The unity gain follower: The somewhat lengthy term operational amplifier will now be dropped and it will be referred to, as most people do, simply as the op amp.  The simplest

X rays., how x rays are produced?

how x rays are produced?

Discount Cash Flow Analysis, How to complete

How to complete

Value analysis, what is value analysis

what is value analysis

Engineering Economy, I need the answers of these three problems. 1. How muc...

I need the answers of these three problems. 1. How much money would be in a savings count that started with a deposit of $2,000 in year 1 with each succeeding amount increasing by

Causes of unbalance - aircraft design, Causes of unbalance Unbalance ma...

Causes of unbalance Unbalance may be caused by a variety of factors occurring singly or in combination with others. These factors include:- a) Eccentricity Eccentricity

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