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

EMI, explain ramp type

explain ramp type

Levelling Theory and Computation, Two readings i.e., 1.64m, and 0.73m, were...

Two readings i.e., 1.64m, and 0.73m, were taken during leveling procedure to define the slope of centerline of a bridge at points A, and B. If distance AB = 50m, find the slope of

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

HOmework, Assume that a movie is two hours long, that the frame rate is 30 ...

Assume that a movie is two hours long, that the frame rate is 30 frames per second, and that the resolution per frame is 1080i (1920×1080 pixels per frame), and that each pixel is

Present worth equivalence in economical engineering, Present Worth equivale...

Present Worth equivalence: Since we have developed the relationship to find a future value F given a present value P, we can easily derive the formula to find a (P|F, i, n), w

Optimization, Wild west produces two types of cowboy hats. Type 1 hat requi...

Wild west produces two types of cowboy hats. Type 1 hat requires twice as much labor time as a type 2. If all the available labor time is dedicated to type 2 alone, the company can

Meer, write drawback of linear array

write drawback of linear array

Fire fighting operations - high rise buildings, Fire fighting operations - ...

Fire fighting operations - high rise buildings: Inlets that allow the fire service to supplement to water to the sprinklers and to the fire mains are useful additions to the m

Heat and mass transfer, Water enters a smooth thin-walled tube of 1 inch di...

Water enters a smooth thin-walled tube of 1 inch diameter at 50F and leaves at 150F. Heat is supplied to the water by condensing steam on the surface of the tube at a constant temp

Governing equations of typical section aerofoil, We recall the "typical sec...

We recall the "typical section" aerofoil model with oscillating pitching and plunging motions to represent the torsional and bending behaviour of a wing structure with large aspect

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