finance lec 4 - CAPITAL RATIONING Flashcards
CAPITAL RATIONING ALL ABOUR
got limited resoures so pick investment descision wisely
hard capital rationig
restrictions imposed externally
e.g depressed share capital prices mean you not attrracive
if existing capital not enough and hoping to make money through share issue you are very limtied
what are the reasons for a companies ltd financial resources
hard capital rationing
soft capital rationing
soft capital rationing
restrictions imposed internallt ny managment
give example of why soft cpaitl rationing is a thing
may be concerns over total finace
when you borrow pay interest - big financial burden - dont pay back you may go into bankruptcy
managers dont want that pressure cuz the more you borrow the more you greater the interest and the burden
why may mangrs not want yuo to issue shares either
when issue shares Sh base grows so now got lots mroe people claiming ownership of firm impacting control
and SH may not like management
how do we calcualte earnings per share
profit of firm / # of shares
in terms of earning per shahre why may firm not want to issue mroe shares
if number of shares increases this reduces the value of the earnings per share
in shrt we dont want to raisse moeny through debt becasue
dont want an additional interest commitment
in most companys there is what budget
capital expenditure
what is the capital expenditure budget
specific amount of moeny managment set aside for I purposes
sum up hard capital rationiogn
external - comp unable to raise any mroe moeny
sum up soft capital rationig
imposed internally by management
due to concerns over total finance
interanl cmopetitive mkt for funds
in soft capital rationing how do is exendityure allocated
based on priorities
in soft cpaital rationing expenditure is allcoated based on priiorities what do priorities depend on
stage the business is at
soft capital rationig if business is at a stage of being a startup and trying to expand as much as possible what will be our top priotity i.e wher e will most finance go
investment division
in terms of soft capital rationig as the business becomes more mature , established and there is not that many investment opportunities avaialble what may company focus on therefore where may put moer of capital expenditure
marketing and PR department
when we refer to capital rationig we refer to
period rationing
what does period rationig mean
capital is only lmited at t0 = present when making a decision about a particular investment opportunity
why dont we need to eb concerned about future limitations on capital
it’s freely available at any point in the future
the time we are making the investmetn descision is the onyl time that
we have limited capital
we need to identify teh cominatino of projects that will maximise the
NPV
We want the highest
what is the profitabilty index calculation
measure of profitabilty
NPV
______
Initial Investment
the higher the profitability index the
better the project in terms of using the limited capital
what does hte profitability index show us
a CBA for a project
the proportion of benefit to cost gives us a CBA and tells us for every £ we invest what benefit we get
when/ what projects do we use the profitability index for
divisibile
non defferable
non repeatable
when we use the profitability index what do to work otu where to allocate capital
i.e. what are the steps
calculate profitability index
rank all projects based on the profitability index
allocate funds to projects in order of ranking and invest till all the funds have been used
what does divisible mean
any portion of project can be undertaken
i,.e can invest only half or full amount
can invest in part of project even if dont have enough capital
what does non defferable mean
if project not undertaken at present it cannot be undertaken later
now or never
non repeatable meaning
undertaken only once - wont have this opportunity to do it again in tht efuture
most project are non deferrable and non repeatable so what should we focus on
whether it is divisiblei
if project is indivisible and we can’t afford it what do we need to do
move onto next project
if project is indivisible / in genral when deciding waht to invest in what do we need to consider
all possible combinations of projects I can afford with 1 milly
the combination we pick of projects we invest in need to give ht ehighest overall
NPV
What are the steps to rank the numbers
take profitability index of projects in each combination . wright thm by the amount hey cost relative to teh total budget
choose the one w the highest weighted avg profit index
if project iis divisible what do we do/ if project is non divisible
divisible - look at PI and rank then allocate finds till run out
non divisible - find combo you can afford w 800,000 then choose highest NPV , calc weighted avg PI for each and pick highest
we we can invest 100% of capital into project what do we get
100% of the return
if the project costs 400k and can only invest 262 k what % of the NPV do we get
262/400 x 100
= 65.5%
if non divisible waht do we do
ID all possible combos we can afford with our cash
work out which combined give highest NPV
rule - choose project with the highest NPV/hihghest weifhted avg PI
If there is a single project with high NPV does this mean you invest in that automatically
no as a combo could give a higher result
used capital is an ….. investment
idle
used capital is an idle investment so what NPV and PI does it give
0
to sum up divisible and non divisible
divisible - rank based on PI , then allocate money to I till run out
indivisible - id all possible afforable combos , the choose one with the highest NPV/- dont acc think you need avg pi for this last part
how do we work out weighted pi
capital investment required(cost of project) /
investment budget available
*
PI
when project not divisible what do you do
consider combo pick one with the highest weighted avg profitability index
