Specific Investment Decisions (2) Flashcards
What is capital rationing?
Arises when insufficient capital to invest in all available projects which have +NPV capital is a limiting factor
What is hard capital rationing?
Firm can’t get finance from capital markets
Reasons for hard capital rationing?
Investors unwilling to invest in equity finance
Lending institutions consider organisation risky
What is soft capital rationing?
An internal management decision to restrict capital spending
Reasons for soft capital rationing?
Reluctant to issue share capital because of delution
Reluctant to issue debt as it affects gearing
Limiting funds creates competition for very best possible projects
Capital rationing for divisible projects?
Work out PV of cash inflows per $ invested
Capital rationing for indivisible projects?
Work out NPV of the affordable combinations of projects
What are divisible projects?
A project thjat can be scaled down and done in part
What does the profitability index measure?
Investment funds are a limiting factor by selecting projects whose cash inflows have highest return per $1 of capital invested
What are non-divisible projects?
A project that must be undertaken completely or not at all
What happens when a project cannot be done in part?
Choice facing a company is not how to spend each $1 so the PI is not used
Appropriate technique for PI?
Identify which project combinations are affordable
Select project combination with highest NPV
Drawback of capital rationing?
Single period only
Not possible to delay any projects
Success of one project is not affected if another project does not proceed
Can’t form a joint venture
