CAPITAL RATIONING

External Capital Rationing Internal Capital Rationing

CAPITAL RATIONING DECISIONS

- Use of NPV

Projects
A B C D

Cash Outlay In 1000s 200 150 100 50

NPV at 10 % In 1000s 18.2 6.8 0 ( 2.3 )

IRR
20 % 15 % 10 % 5%

Cumulative Cumulative Cash NPV Outlay 200 350 450 500 18.2 25.0 25.0 22 %

CAPITAL RATIONING DECISIONS - Use of Profitability Index

Projects L M N

Cash Flows ( Rs in 1000s)

C0
-50

C1 + 30 + 10 + 10

C2 + 25 + 20 + 15

C3 + 20 + 10 + 15

NPV 10 % 12.94 8.12 7.75

PI 1.26 1.32 1.31

-25

-25

Limitations of Analysis

Multi Period Capital constraints

Project Indivisibility

Investment Analysis & Inflation

Interest rate and Inflation

Inflation and Cash Flows

Cost of Capital
Optimal Capital Structure Capital : Equity Debt Retained Earnings Preferred Stock

Cost Of Debt
Kd = r ( 1- t )
Where r = Interest rate t = tax rate

COST OF PREFERRED STOCK

K p= Dp / r

Dp

DIVIDEND OF EQUITY

r =

RETURN EXPECTED

Cost Of Equity Stock

where i = interest payable to debt unadjusted for tax advantage
Capital Asset Pricing Model

Ke = i + risk premium

Ke = rf + ( rm rf )
Where rf risk free return rm market return on equity funds - firms beta that measures the systematic risk associated with the company

Cost Of Equity Stock

Stock Dividend and Growth Rate Model

Ke = (Do (1 + g ) / P) + g
Where Do dividend payable in beginning P is the price of the market in stock g growth in dividend

PRICE EARNING MODEL

P =

EARNING PER SHARE MARKET PRICE OF THE EQUITY

WTED . AVG . COST CAPITAL

SOURCE AMOUNT COST

EQUITY A1 DEBENT. A2 PREF SHARE A3

r1 r2 r3

WACC =
N =

(A1/N)*r1 + (A2/N)*r2 +(A3/N)*r3 N A1 + A2 + A3