Financial Management Unit 10Sikkim Manipal University
generating the management’s expectation on the rate of return will be cleared. Generally internalcapital rationing is used by a firm as a means of financial control.
Self Assessment Questions 1
1. When a firm imposes constraints on the total size of its capital budget, it is known as _____________.2. Internal capital rationing is used by a firm as a ______________________.3. Rigidities that affect the free flow of capital between firms cause _________________.4. Inability of a firm to satisfy the regularity norms for issue of equity shares for tapping the marketfor funds causes __________________.
Steps involved in Capital Rationing
Steps involved in Capital Rationing are:1. Ranking of different investment proposals2. Selection of the most profitable investment proposal
Ranking of different investment proposals
The various investment proposals should be ranked on the basis of their profitability. Ranking isdone on the basis of NPV, Profitability index or IRR in the descending order.
Profitability index as the basis of Capital Rationing
The following details are available:
Cash InflowsProject Initial Cash outlay Year 1 Year 2 Year 3
A 1,00,000 60,000 50,000 40,000B 50,000 20,000 40,000 20,000C 50,000 20,000 30,000 30,000Cost of Capital is 15 %Computation of NPV
Year Cash in flows PV factor at 15% PV of Cash inflows
1 60,000 0.870 52,2002 50,000 0.756 37,8003 40,000 0.658 26,320