CAPITAL RATIONING (NPV OPTIMUM) - FINANCIAL MANAGEMENT CPA KASNEB

Capital rationing in financial management refers to the situation where a company has a limited amount of capital to invest, and therefore must prioritize and allocate it among competing projects or investments. This constraint often leads to choosing only the most profitable projects or the ones that align best with the company’s strategic goals, rather than funding all viable opportunities.
Types of Capital Rationing
1. Hard Capital Rationing: Occurs when external factors limit the company's ability to raise capital, such as difficulties in securing loans or issuing equity due to market conditions or company-specific factors.
2. Soft Capital Rationing: Involves self-imposed limits on investment by the company. This could be due to managerial policies that aim to maintain control over the capital structure, avoid over-leverage, or ensure a specific return on investment.
Reasons for Capital Rationing
• Financial Constraints: Limited access to funds from external sources like banks or investors.
• Risk Management: Limiting investment to avoid overextending the company and managing exposure to risk.
• Strategic Focus: Ensuring that only projects that align with the long-term goals of the organization are funded.
• Cost of Capital: High cost of raising new funds, leading to selective investment decisions.
Methods of Capital Rationing
• Profitability Index (PI): Ranking projects based on the profitability index, which is the ratio of the present value of future cash flows to the initial investment.
• Net Present Value (NPV): Prioritizing projects with the highest NPV within the available capital.
• Internal Rate of Return (IRR): Selecting projects that exceed a certain IRR threshold.

[@patriciamaasi3315]

Thank you for this 🙏

[@AringoFredrick]

You’re welcome 😊