What is Capital Rationing in Financial Management

Business firms commonly find that there are more acceptable projects than they have the money to undertake, Thus, numerous projects may compete for those limited resources. In such circumstances, firm must ration them, allocating funds to projects in a manner that maximizes the long-run returns.

This is generally, done by selecting the group of acceptable projects that has the highest overall present value of inflows and does not require more dollars than are budgeted. A number of capital rationing approaches are available such as the Internal Rate of Return approach, the present value approach and the use of integer programming.

Whichever, approach is used, it should be remembered that all the project considered must be independent. If there are mutually exclusive projects, the best of these should be choosen and placed in the group of independent projects.

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