Capital Rationing

Question 1

What is capital rationing and what are its types?

Answer 1

A situation where a company has limited capital for investment, requiring comparison of potential projects to allocate capital effectively.

Soft, hard

Question 2

Soft Capital Rationing

Answer 2

Caused by internal factors such as management decisions, often to avoid dilution of earnings per share or to prevent high fixed interest payments due to additional debt.

Question 3

Hard Capital Rationing

Answer 3

Caused by external factors like market conditions or borrowing restrictions imposed by lenders.

Question 4

Relaxation Techniques

Answer 4

Strategies like joint ventures, licensing agreements, contracting out, or seeking alternative capital sources to mitigate capital constraints.

Question 5

What is Multi Period Capital Rationing?

Answer 5

• Multi Period Capital Rationing: Occurs when there is capital rationing over multiple years and projects require finance each year. It necessitates identifying the project combination that maximizes total NPV.

Question 6

How is Multi Period Capital Rationing addressed? [3]

Answer 6

• Linear Programming: Used to find the NPV-maximizing combination of divisible projects.
• Graphical Approach: Applicable for solving linear programs with only two projects.
• Simplex Technique: Required for more than two projects to solve the linear program.