FN543 Investment Appraisal: Capital Rationing

Flashcards covering the key concepts of capital rationing.

What is the "Perfect capital markets" assumption?

A company has access to unlimited funds.

What is a "Capital Rationing Situation"?

A company does not have sufficient funds to undertake all projects that have a positive net present value.

What are the two types of capital rationing?

Single-period and Multi-period

What is Hard capital rationing?

Forces external to the company will not supply unlimited funds.

What is Soft capital rationing?

Forces internal to the company limit the amount of capital available.

What are the steps in the decision-making process for single-period capital rationing?

Calculate NPVs, Express each NPV as a benefit-cost ratio, Rank projects, Accept as many projects as possible.

What is the formula for Benefit-Cost Ratio?

NPV / Initial Investment

Why does the IRR investment appraisal technique fail in the context of capital rationing?

IRR is an absolute percentage rate of return, it doesn't measure project performance relative to the rationed investment outlay.

What is involved in Multi-period capital rationing?

Capital rationing extends over a number of future periods

What is a solution for Multi-period capital rationing?

The linear programming solution