Capital Rationing

6 Key excerpts on "Capital Rationing"

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  Capital Budgeting

  Top-Management Policy on Plant, Equipment, and Product Development

  • Joel Dean(Author)
  • 2019(Publication Date)
  • Columbia University Press

    (Publisher)

  For example, in the petroleum industry, a company might seek, as a long-run objective, a 50 percent CAPITAL R A T I O N I N G 79 growth in a decade and the attainment at the end of ten years of crude-oil production and refining facilities that equal its marketing demand. Such a goal may provide a criterion for approving and rejecting investment proposals. Whether it will be a more satisfactory criterion than the rate-of-return ration-ing plan outlined above is doubtful. The effects of this kind of plan upon the company's long-run rate of return are difficult to determine, because this approach views the company as a monolithic strategic investment. Balance usually means some form of vertical integration, and vertical integration has not proved universally profitable in all industries, nor is it sure to reduce the hazards of the enterprise. Another device is postponability screening. Sometimes both the total amount and the allocation among individual projects are determined by whether or not the proposed investment can be put off. 11 (An appraisal of postponability is found in Chap-ter II.) SUMMARY Capital Rationing is central in the planning and control of capital expenditures, since requests for funds normally exceed supply. Screening proposals on the basis of their prospective rate of return (when measurable) puts Capital Rationing on an economically sound foundation and limits the degree to 1 1 A New York lawyer innocent of any experience with feathered chickens bought a rundown chicken farm in southern New Jersey and hired a local farmer to run it. Every two months he toured his domain with the farmer, who invariably pointed out needs for capital expenditures—new chicken coops, fences, and so on. The lawyer's invariable reply to the first request for a project was, Money is scarce; you will just have to fix it up and make do. The second time th; projcct came up, the reply was the same. If a project was requested a third time, it was granted.

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  The Capital Budgeting Decision

  Economic Analysis of Investment Projects

  • Harold Bierman, Jr., Seymour Smidt(Authors)
  • 2012(Publication Date)
  • Routledge

    (Publisher)

  Chapter 6

  Capital Budgeting Under Capital Rationing

  In practice we have tacitly agreed, as a rule, to fall back on what is, in truth, a convention. The essence of this convention – though it does not, of course, work out quite so simply – lies in assuming that the existing state of affairs will continue indefinitely, except insofar as we have specific reasons to expect a change.

  J. M. Keynes

  In the preceding chapters we concluded that, under conditions of certainty, if a firm could borrow or lend funds at a given market rate of interest, it should accept independent investments when the investments have positive net present values at this market rate of interest. In this chapter we consider situations in which the assumption that a firm can borrow or lend any quantity of funds that it desires at a given market rate of interest is not valid. There are two distinctly different Capital Rationing situations in which this assumption may not hold. We assume away the problem of projects and firms having different risks.

  One of these capital-rationing situations arises because of a decision by management either to limit arbitrarily the total amount invested or the kind of investments the firm undertakes or to set acceptance criteria that lead it to reject some investments that are advantageous when judged by market criteria. For Example, instead of using the market interest rate, the firm might use some higher rate as a cutoff or hurdle rate.

  A second capital-rationing situation that must be considered is when there is a difference between the market rate of interest at which the firm can borrow money and the market rate at which it can lend.

  Both situations are frequently labeled Capital Rationing. To distinguish between them, we shall refer to the former situation as internal Capital Rationing and to the latter as external Capital Rationing

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  ACCA Financial Management

  Practice and Revision Kit

  • BPP Learning Media(Author)
  • 2021(Publication Date)
  • BPP Learning Media

    (Publisher)

  If a company only requires a small amount of finance, issue costs may be so high that using external sources of finance is not practical. Reasons for hard Capital Rationing may be company-specific, for example, a company may not be able to raise new debt finance if banks or investors see the company as being too risky to lend to. The company may have high gearing or low interest cover, or a poor track record, or if recently incorporated, no track record at all. Companies in the service sector may not be able to offer assets as security for new loans. Reasons for soft Capital Rationing include managerial aversion to issuing new equity, for example, a company may want to avoid potential dilution of its EPS or avoid the possibility of becoming a takeover target. Managers might alternatively be averse to issuing new debt and taking on a commitment to increased fixed interest payments, for example, if the economic outlook for its markets is poor. Soft Capital Rationing might also arise because managers wish to finance new investment from retained earnings, for example, as part of a policy of controlled organisational growth, rather than a sudden increase in size which might result from undertaking all investments with a positive net present value. One reason for soft Capital Rationing may be that managers want investment projects to compete for funds, in the belief that this will result in the acceptance of stronger, more robust investment projects. (ii) Ways in which Dink Co's external Capital Rationing might be overcome Dink Co is a small company and the hard Capital Rationing it is experiencing is a common problem for SMEs, referred to as the funding gap. A first step towards overcoming its Capital Rationing could be for Dink Co to obtain information about available sources of finance, since SMEs may lack understanding in this area. One way of overcoming the company's Capital Rationing might be business angel financing.

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  Corporate Finance

  • Peter Moles, Robert Parrino, David S. Kidwell(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  Our discussion of capital budgeting so far has focused on tools that help us determine whether an individual project creates value for sharehold- ers, as well as helping us better understand other economic characteristics of projects. Although these analyses are critical parts of the capital budgeting process, they get us only part way to where we want to be. They do not tell us what to do when, as is often the case, a firm does not have enough money to invest in all available positive NPV projects. In other words, they do not tell us how to identify the bundle or combination of positive NPV projects that creates the greatest total value for shareholders when there are capital constraints or, as we called it in Chapter 10, Capital Rationing. In an ideal world, of course, we could accept all positive NPV projects because we would be able to finance them. If managers and investors agreed on which projects had positive NPVs, investors would provide capital to those projects because returns from them would be greater than the returns the investors could earn elsewhere in the capital markets. However, the world is not ideal and, as noted in Chapter 10, firms often cannot invest in all of the available projects with positive NPVs. It can be difficult for outside investors to accurately assess the risks and returns associated with the firm’s projects. Consequently, investors may require returns for their capital that are too high and the firm may face capital con- straints. Managers might be forced to reject posi- tive NPV projects because investors are not providing enough capital to fund those projects at reasonable rates. Capital Rationing in a Single Period The basic principle that we follow in choosing the set of projects that creates the greatest value in a given period is to select the projects that yield the largest value per unit of money invested.

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  Fundamentals of Corporate Finance

  • Robert Parrino, David S. Kidwell, Thomas Bates(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  Capital Rationing across Multiple Periods The PI concept is relatively straightforward and easy to apply if you are choosing among pro-jects in a single period. However, if you are faced with Capital Rationing over several years, the investments you choose this year can affect your ability to make investments in future years. EVALUATING PROJECT ECONOMICS AND Capital Rationing 426 This can happen if you plan on reinvesting some or all of the cash flows generated by the pro-jects you invest in this year. In such a situation, you cannot rely solely on the PI to identify the projects you should invest in this year. You must maximise the total NPV across all of the years in which you will be investing. Let us look more closely at how multi-period concerns can cause you to deviate from PI-based investment choices in a given year. Suppose you operate a business that will generate €10 000 per year for new investments. Furthermore, suppose that today (year 0) you are choos-ing among projects A, B, C and D in Exhibit 12.11 and that, based on the PIs of the individual projects, you choose to invest in projects A, B and D.

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  Handbook of Military Industrial Engineering

  • Adedeji B. Badiru, Marlin U. Thomas, Adedeji B. Badiru, Marlin U. Thomas(Authors)
  • 2009(Publication Date)
  • CRC Press

    (Publisher)

  Line workers familiar with specific activities are requested to provide cost estimates. Estimates are made for each activity in terms of labor time, materials, and machine time. The estimates are then converted to an appropriate cost basis. The dollar estimates are combined into composite budgets at each successive level up the budgeting hierarchy. If estimate discrep-ancies develop, they can be resolved through the intervention of senior management, middle management, functional managers, project manager, accountants, or standard cost consultants. Optimization Model for Military Budget Allocation and Capital Rationing 8 -3 8.4 General Formulation of Budget Allocation Problem A general formulation for Capital Rationing involves selecting a combination of projects that will opti-mize the return on investment or maximize system effectiveness. A general formulation of the capital budgeting (Badiru and Omitaomu 2007) problem is presented: Maximize Subjec z v x i i i n 1 t to c x B i i i n 1 x i n i 0 1 1 , ; , ..., where n number of projects; v i measure of performance for project i (e.g. present value); c i cost of project i; x i indicator variable for project i ; B budget availability level. A solution of the above model will indicate what projects should be selected in combination with other projects. The example that follows illustrates a Capital Rationing problem. Planning a portfolio of projects is essential in resource-limited projects. The capital-rationing formulation that follows demonstrates how to determine the optimal combination of project investments (or budget alloca-tions) so as to maximize total return on investment or total system effectiveness. Suppose a project analyst is given N projects, X 1 , X 2 , X 3 , …, X N , with the requirement to determine the level of invest-ment in each project so that total investment return is maximized subject to a specified limit on avail-able budget. We assume that the projects are not mutually exclusive.

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