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

Chromizing, advantages and disadvantages

advantages and disadvantages

#title., problem on dissociation constant

problem on dissociation constant

Extractive metallurgy, differences between blast , reverbatory and electric...

differences between blast , reverbatory and electric furnaces

What features of our solar system, Expertsmind.com brings you unique solut...

Expertsmind.com brings you unique solution in physics What features of our solar system provide clues to how it formed? 1- Patterns of motions among large bodies: -

Introduction to Corporate Finance, Calculatethe tax disadvantage to organiz...

Calculatethe tax disadvantage to organizing a U.S. business today, after passage of the Jobs and growth Tax relief reconciliation act of 2003, as a corporation versus a partnership

Limited travel distances - means of escape, Limited travel distances - mean...

Limited travel distances - means of escape: Are travel distances within the maximum allowable distances published in the guidance? Is there good visibility in the

Calculate the heat transfer coefficient , Water is flowing at 0.5 ms-1 acro...

Water is flowing at 0.5 ms-1 across a 7.5 cm diameter sausage at 80°C. If the bulk water temperature is 15°C, estimate the heat-transfer coefficient. a) What type of heat tranfe

#title.MARKET VALUE WEIGHT OF EQUITY., AAA has 1,000,000 shares of common s...

AAA has 1,000,000 shares of common stock trading at $20.00 per share. The company''s debt consists of 2,000 $1,000 par value 10-year 7.0% annual coupon bonds with semiannual paymen

About acidityb of floure, why wehabve to determine the acidity of floure

why wehabve to determine the acidity of floure

Thrust augmentation - aircraft engine , Thrust augmentation: There are ...

Thrust augmentation: There are occasions when the maximum thrust from a basic gas turbine engine is inadequate and some method of increasing the available thrust is required wi

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