I p.

ationing
111·~ 137

duction - Capital Rationing - Meanina -_,;_~ ·~.Disaclvantaps .£Solved·:

blems - Questions for Self-Practice. • .. . ,. .

ductlon . •
' ... "

...
'1 1
•
.,
''"'J'"'rl ...
.&

•··• . .: ... : ~·--·1 ...":--.~-~---

0
I"
..
,_•• ,..,;,..,1
~~
,fJ.-.•
1
, _.,r)
_.:_, .. · _• ........ -: •.. ..--.-

apital rationing refers to a situation where afirm is constrained for :

-imposed or external reasons;' to ~tam·necessaty funds·to inv~t in -;
profitable investment projects. Such constraints which· lead to a l
· ion to keep capital expenditures within a ceiling during·a specified_:
od of time may arise due to .self-imposed. restrictions ;or market ;
itions. It has beert stated·.-earlier .that betwee11:NPV .'and PI .the 1 •
,· , ,,. •' ' . . ., .>-, . , •

rence is that the former attempts to analy~g the value of the firm
bsolute terms while the latter; in relative terms..Under the capital
ning the objective is to. _select .the__ combination.~o(_investment _
sals that provide the highest net p~t values> subjecf to the :
get constraint for the period;- ·. · ::·,~--- -----,----··-.------~
• •• \ 1 ,,,. >

In capital rationing the pr9jects_~ -~ -r ~ , using the,PI method '.

escending order of .profitab~ty-~Thereafter- ~ --;l:>1:~ .wiµ .be_!_:.
ted in descending order of ~~~_,~bilifyc:~til -the -~ ~..- ~ are 7
usted. The selection of the proJeds nught result in part of the ,
geted fund being unused. Selection:-or~1ects-·o~ ·~ --~~-~will -j
yzing the value of the firm un~.~e conditifns of capital r~ttorung. ; .
antages of Capital Rationing: ·.'.- ·..-,------··:•~· -~~~-~;-~~.-- ·-~·-:: ·-·.--: {
·1·
Fac11tates ·. · f the ~ that - ... ~"'i 7 ,ac the.firm's .value
selection o P~"',-.- ~ ----- .. ~~~ · · ·· :; · ·
. . . •ec1 " ..,.-:···-''····~--
Whenthecapitalislimit .-,.::.:, ..." .. ·.. ;,,,.-~• •t·-· . • . • ·,_.. · . .
··-~ ·' .•.• _· · .·.··_ .. ·-'I

Results in rational allocation of limited financial resources. · .· : · th .:

·
Pro1ect · · ·d · the restrictions on e
selection can be done C0~1 enng ,
availability and use of funds. ·
 ,id
138 ~,.Wfrl"' Vipul's™ Financial Management. II (&\t} .~·

(d) Selection of the "best" project and rejection of the non-viable ones. ;:,
Disadvanta ges of Capital Rationing: ' f~
(a) Restrictions on the amount of new · investments or projects
· undertaken by a company.
(b) Firm cannot ~ake up all the projects with po~itive NPV.
(c) Difficult in finding an efficient procedure for preparing and
reviewing capital budgets in conditions of capital rationing. .~
(d) Difficult to forecast correctly the cash flows that can be ~xpected to -~
result .from specified investment proposals, as well as the liquid
resources that will be available for investment. ·
(e) Problem in rationing the available capital or liquid resources among
competing investment opportunities. ·..
i.i

SOLVE D PROBL EMS

Illustration 1: .
lndica Chemicals Ltd. is considerin the followin ro·ects: fl!
Project Outlay NPV
Rs. Rs.
A . 1,60,000 65,000
B . 1,40,000 50,000
C 1,20,000 45,000
D, 80,000 30,000 ~
. E · 70,000 32 000 ·
Projects B and C are mutually exclusive; so are projects Dand E. The capital budget ~ ~
1

is Rs. 3,00,000. ..
, Choose the feasible combination that has the highest NPV. Give Reason. t~
·Solution: ~
. Combination I: ·. Outlay NPV ;,

Rs. Rs.
A 1,60,000 65,000
B 1,40,000 50,000
3,00,000 115000
Returns %=38.33%
Combination II: Outlay
Rs.
A 1,60,000
E 70,000
2,30,000
Returns °.4 = 42.17 % . .
Suggestions: Combination I is because NPV is highest as · · ed Combi tiOn n. 1
Combination II because Returns on Capital invested inte com~r to ':a,.;~ ,
Is
the surplus ~s. 70,000 has a profitable investment avenue. Berms ohepercentageR15,-,
ware, re s. 18,000 1,
( Ill' ~
\
97,000] less is earned.
 ,J
°'ll'l
·1
. 1·1·,:. /39
2
uTsatnraotL .. tn ··:i;·;::·''I,>·~··.. ·.· ... ;··;•··. :,...
iotdn.,·s ~onsiderin thefollow ~: .:-:- . . : . _.-:'! .. ~,·
1
Pro'ect .. :· :.:·-,·.'·· :) : ~- ~.r- .·. :•. ··~ .. ;
A , , ,· NPV Rs. ·· :·
6 • . "'• ,1, 11•' t I 'l . ' I :f
·.: .. :• ,0.00,000 : "'. ·. '"·':'., ,,··:·: ··- -· ... : ',. 5.00,000 ; '11.,..·
C '' ·., , 900000 · ·•.·. · ·, !-' . · 450000 · .· :
D . , ', I ' ' . .. ' I •. . .. ' ,' '

E ,· :',;,\·:::,-,,7e,Qp.Q00-~.7,.;:·r:-:-r~-1, ....~ • .. t·. 34,~,000000 , , ..

11N, 1··•• ,·.... ~ .. .. -~
', ooooo l.... ,.,. . .·J,:,.l .. t:h,~::!, . . :·"·•·

Capital budget constraint of Rs. 25 00 000 . . · .. · ·: 2 50 000 '

NPV
Rs.
A .......
•• 1.
,; ·•· ······
B . .. ~' •·· ,. .. ~--. . --~ ... ....
.

l. ,,
9.5 llcl
Alternative II: • I NPY . . ·:· ;,r •~·.

Alternative Ill:

B
D
E

Suggestion: Alternative Ill will be selected because: tht tfltint outlay wl be utilsed and also
aggreg~te NPVis maximum as corriparedto~eslandll_- .... . ~-:·:..· . ..
ustrat1on 3·• i-.• ,. ,
. . • ,,.., . ..
>r.·-,. ,,,.:,•.
, ·-~• ,...........
J r;, .•
•. ........
............ ... ~· ..... ·-·· . . .. - , . - ..
•
J •• ' , · · : _ . . . .. . ·.

T ~

otal available fund for capital expenditure lri ·a year

1n·a 1rm:1s estlinated at~: 2 lakhs. The
~all exclusive investment ro sals alo ' · rofflabi Index are below: ' '
ect A B : c D •- E f ·.· G
Outlay (Rs •'000) . •. 35 . , .. ~L•· .IJ& . • . . • •. aft .,..... . ... 20 ......
'· '. ,,. . 40 . . . 20
25 ~ ~ a, ; ' ~
0

., -1• .\ • • ••

0,94 I' : 1.18 ,' ,_.V 1.'14 " ' ' f . • . '1.05' . .• 1.09 1.19

efirs . to be rejected as Its Pl .I s• •· · .

1five projects will utilise the . ...... ..... ...... , . :
r

140
Vipul's™ Financial Management. u(11.j r/
#
lll~t:!'
oronnsals is also aiven:
Investment proposals are competing tor selection. The Pl ol each~ i-. r
/
Prooosal p a R s
Initial Outlay (Rs. '000) 25 35 40 ~I
Pl 1.13 1.1'1 1.15 1.08
If the budgeted fund is Rs. 60,000; select the most profitable projects. --.... ~
\ I Solution:
,-____::..:..:.:..-;:::-Ra :-:n-:-k----.-----=P-ro-o ,o-s---:-al---.------P::-: 1---- !OO

1 R 1.15 - mustra
2 P 1.13 l, n~•r
U,~

3 a 1.11 : ~

=====~4=====;::=::====,===s====r==:;:;;====::;:::~1.oa~==:::=J·1__.. -
' 11
Mix/ Initial Outlay Inflow = NPV = [I
Combination Proposal (Rs.) Pl Outlay x Pl Inflow less 0utllol
(Rs.) (Rs.)
(1) (2) (3) 4) (3 (4): (5) 5)-(3): (6)
! R
P
40,000
25,000
1.15
1.13
X

46,000
28,250
6,000
3,250
3 P 25,000 1.13 2a,2so a,2so · I nm
a 35,ooo 1.11 38,850 3,850 , ~lutior
, . . 60,00Q 67,100 7,1()() I r;~I
Suggest1~n: Combinat,~n 3 gives the highest NPV than that of 1 or 2. In this case the firm wl
be able to put its scarce capital to its optimum use.
I~
Cipt
Illustration 5: :-----1
Jack & Jill Ltd. furnishes the following information-
Investment Limit : Rs. 7,00,00,000. ·
Project Initial Outlay NPV
(Rs. in Lacs) (Rs. In Lacs)
M 340
N 26.7
280
0 36.7
300
p 320 38 8
·
Rank them on Pl and select them Al d . 70.6 ~
~
-::--
.....i
projects. All projects are DIVISIBLE i ~o et~rmrne the aggregate NPV for the ~ ~
relation to the availability of funds. No~~ s~zt~ of rn~estment can be reduced, HnecessarY' ~ ~~
than once. 0
e ProJects can be delayed or undertakefl rf'{Jt ~
Solution: \ ,
~~~
ItlPPr~oJ:Jo~it:tatI_R=artiocnc1·~81g~h=~,
n Rn~fslk,ow
.i;70~0~1a~kh~s~faic
=NPV + Initial Outlay iutia;--r---=--=------ ---
__,
.J> \~

r- ~-7r-~~~~¥
M
N
O
26.7+340=366.7 7
36,7+280 = 316.7
38.8 +300:'338.8
-~~~P~I~:~C~as~h~ln~f~low~_J_~
CashOutflow
' 366-7 + 340:1.0785
316-7 + 280:1.1311
~-::_.....- I
N
I
I
j
.....___
7
P_ --1L--_ ___:_~0.!!..:6+!.,:3~2~0=
:,.:3~90~.SL__ _JLj~90~38~::~:]~;20~=~~~:~~29~-1__J~ I

l
\ (

fi
fi
 •
..
:. • • • r' _.I . t
.. •.
rrrrrr 141
Pro)~ ; . ~;. i , 1• • -. ..~ , .,:./. :,;,_ ,· ... ' ... ' ; . •: :·-., / ."·

I
II

><
111

.. . , ., .. -- ~•-: --- .... --:....-.., ... ... ·•·· ..--- ..

_ ~....

300 38.8
100 ?

Q •.
. .·-:·,t,J:.~::•1:·
10 ···~· .•· . ... J . I 200
. . . . -_,.~--,- ......._, • ~~----·--·~ ··- ·--~-.
R .. , 3S · ., , ;· . 9.0
S · ~~, -· f •·· 12
. 32 l'i · ; ,•
64
a and R are mutually exclusive. None of the
combinar ~ ~-
·
more than once. Suggest the 'most feasible dela~~ or::i- undertaken 1·
lution: , · --· .... -- , . .. • .' ..
i ·r ·
!
"
· ; .
~
= Rs. 70 Lakhs- "'-· ·,·-- ~ '. .· .... ·. , ' .•t·... - : ,.:· ~ . ·.· ·\'.v,\ :d
t. , ••

(,
i·

Option Project lnltla!.10utlay· ·'.• NPV .·.

• NI Lacs In Lacs
P · -·· ·-- . . . . . . SO. . 20.0
a : . · 10 9.0·
60 29.0
II

Ill

Sugges!ion: Option I (i.e. Project Pand Q); since the NPV of th~ ~natk?,l ~-~ h~~-11r
Note:lt1sassumedthatallthep,:~ar~Jndiylsible•..•.,.... , ..... .. ·...
ustratio 7· ·, ~- -, ·_;l~J •• ,·ltlt ,111'.•JIUV~.c-1,j. ,l...iL, .• J n.' ,r,,.l,1
:.~'·-~,.:-.i·; . . ·
n • . , 1 _.:·• •·. ~r ·~ f • ~,,'I i --'1 •:' ·. v:•-)~lj,,·'"; .',, ·~ ,.~ ) ... ~ . •.,
f}

The total available budget for the company Is A& 20 lacs. Thi Projects have beeri ranked in 0

order of Profitabili · . • ,. · ·.• ·\ ·· • · •· ···• ,, "' •.•

Project
M
N
0
p
a
R • , U ..,) ) : ' It•' • ·:! .•· 11 i. •:) 1 t •. •\.,... ., •·· ,.. ·. • . ... i ·

Ci)aculate-
I ·, ~·•· ~· ·'
•· ,.,,
. ' -. · •"':·. ·!Ti"• ". ..... .. . ~~· . . ,. , , , . .
i1, ,c, '•• ,_, ., d ) ' • 1 • } " •' •'• • • .•

( Cash Inflow for each of u111J t"VJ-:"'' • 1 :·, • • • , • •, v ·.... ,

(ii) Net Present Value for eidi·ot~
profectS, ,.. ·. ·· · \ · ·- ,. · ·
 '

142 ~
"'l'rrr
·- •.,,
Vipul'sr~ Financial Management. 11 (~
1
IiI~
k n by the company in order to maximise 1he v
(b) Which projects should b~ unRdet~a .~ assuming that the each Project is lnd'Msible "- /
Present Value under Capital a ,oni 9 7
Solution: Net Present Value~
I<

Pfoi-1 Cost.'Cash Cash Inflow = C h I fl C ,

,- Outflow Profitability Index x Present as n ows - ash ~ :
Value Of cash Outflows 1
(Rs. In Lacs (Rs. In lacs --.......,, 11~
(Rs. In Lacs)
M 6 1.50 >< 6 =9·00 3.00 ~ '/ ~U
N 5 1.25 )( 5 = 6.25 1.25 ! ·: ,~
0 7 1.20 )( 7 = 8.40 1-40 t ·~ I
p 2 1.15 x 2 = 2.30 o.30 ;: ~
a 5 1.10 >< 5 = 5.50 0.50 ! .:
R 13 1.40 x 13 = 18.20 5·20 __ ~
)"

Alternative Project Project Cos t Npv ~

;, •
,.,1
Combinations (Rs. In lacs) (Rs. In lacs)
1
; ~1
p 2 0.30 1
a s .
050 :: ""
A 13 5.20 i
Total 20 6.00 1

2 M 6 3.00 I
R 13 5.20 , _
Highest NPV ➔ Total 19 820
. I ""I
...
3 N 5 1.25 I
0 1 1.40 I ..
p 2 0,30 I

a · s o.so J
Total 19 3.45 1

4 M 6 3.00 i , -.
N S 1.25 1
t1!
0 7 1.40 I

P 2 0.30 - ""
Total 20 5.95 __,
Suggestion: The company will maximise its NPV by undertaking projects M a~d ~• wlltft
require total funds of Rs. 19 lacs. Even though there is no full utilisation of total funds still this optat
is suggested. The surplus funds of Rs. 1 lac can be deployed profitably elsewhere. :·~
Illustration 8: . . . . . ~ ~}
Navnirman Ud.1s considenng four capital proiects for the year 2010 and 2011. The~ .~
financed by equity entirely and Its cost of capital is 12%. The expected cash flows of the
are as below:
~,~
~ .,.~
"'<
Year and Cash flows (Rs. '000)
Project
2010 2011 2012 2013 ~
A (40) (30) 45 55
B (50) (60) 70 80
C
- (90) 55 65
. 0 (60) 20 40 50 _
Note: Figures In brackets present cash outflows. r, \.
~
All projects are indivisible I.e. size of investment cannot be reduced. None of the proied' \,1
be delay~ 01 unde~ken ~e than once. Calculate which project{s) Navnirman Ltd-. " ,
undertake if the capital available for Investment is limited to Rs. In 2010 and f/111
110 000
limitation In subsequent years. For your analysis use the following pre;e~t value factoft.
 . '

143

• P cta ,. . , ,, ."' l'I, • Rs. In 000

· , . Pro 0
Factor CF NPV CF , , ·. ,.ro ect C ·
1.00 {40) :
{40) , , . (SO) . .. ~v . _ ,;, CF_ NP~ cF NPV

Option II TA-:-C, 01
Project
.A
C'
o.

Option Ill 1B, C, 01

Project
B
C
D

. '•
•,•
/44
Vipul'•™ financial Management.
11 (¾J /'
Solutio n: Situation
1;
I J'
,>t
f (b}
I

(a)
projects are
Projects are
Divisible
Indivisibl e

t t
Ranking
Ranking based
on NPV based on Pl
Situation (a)·. Projects are Indivisible· .
(Amt In Rs
Cash Inflow = NPV= Ranking '
Proje Cash Inflow - based
Cash outflows Pl Pl x Cash
ct Cash Outflow
outflows NPV
(1) (2) (3) (2) X (3) : (4) (4) (2) = (5) _(6)
1 1,50,000 1.22 1,83,000 33,000 Ill
2 75,000 0.95 71 ,250 (3,750) -
3 1,75,000 1.20 2,10,000 35,000 II
4 2,25,000 1.18 2,65,500 40,500 I
5 1,00,000 1.20 1,20,000 20,000 IV
6 2,00,000 1.05 2,10,000 10,000 V 1I
Selection of Projects
Fund Available= Rs. 5,00,000 Amt. In Rs.
Rahk Pro·ect Cash outflows NPV
I 4 2,25,000 40,500
II 3 1,75,000 35,000
IV 5 1,00,000 20,000
Total 5,00,000 95,500 ~
Note: Project - 1 (Rank • Ill) cannot be selected as it will require a cash outlay of Rs. 1,50,000 which ~
beyond the capital rationed. 1
Situation (b): When projects are Divisible:

Pro·ect Amt. in Rs.

Pl Rankin based on Pl
1 1.22
2 I
0.95
3 V
1.20
4 II
1.18
5 111
1.20
6 II
1.05
IV
Selection of Projects
Ca ital Rationed = Rs. 5,00,000
Rank Pro·ect Amt. In RS,
I Cash outflows NPV
1
II 3 1,50,000 33,000
II 5 1,75,000 · 35,000
Ill 4• 1,oo,000 20,000
75,000 13 500
Total r-~~ 5 ~--- i---. !#• ~-
• Size of investment reduced to availability of funds. ,oo,ooo 1,01,500
 rl"'rl"'~
= ~ = 145

NPV

X
75,00Q X 40,500
40,500
?

= 2is,ooo
= Rs. 13,500
tration 10: (Oct. 18)
d Ltd is considering following projects which are divisible in nature, you are asked to
the optimal pro·ect if ca ital constraint is Rs. 65,00,000. ·
Pro·ect Initial Outla Rs. NPV Rs.
A 51,00,000 17,00,000
B 12,00,000 3,05,000
C 2,00,000 (16,000)
D 20,00,000 5,25,000
E 10,00,000 2,30,000

ation: Projects are Divisible

erion: Rankin based on Pl
Initial Outlay NPV Pl Ranking Based on
Rs. Pl

II I l l 17,00,000 68,00,000 1.33 .I

II I l l 3,05,000 15,05,000 1.25 Ill
II II I (16,000) 1,84,000 0.92 ·v
I II I l l 5,25,000 25,25,000 1.26 . . II
10,00,000 2,30,000 ·· 12,30,000 1.23 IV
ital available = Rs. 65,000
Rankin Based on Pl Initial Outla Rs. NPV Rs.
I 51,00,000 17,00,000
II 14,00,000 ·3,67,500
Total 65,00,000 20,67,500
Working Note:
putation of Pro-Rata NPV of Project - D
In ltlal Outlay NPV
20,00,000 . 5,25,000
X ... ,,'.I •
14,00,000 IT]
14,00,000 X 5,25,000
= 20,00,000
=Rs. 3,67,500
tration 11: (April.19)
Ud. has Rs. 5,00,000 allocated for capital budgeting purposes. The following proposals
iated rofitabili index have been determined.
, Outflow Profltabll Index
1,50,000 1.22
75,000 0.95
2
3 1,75,000 1.20
4
2,25,000 1.18
1,00,000 1.20
- 5 2,00,000 1.05
6
r

Vfp•d's™ Financial Management". II (SAF)

146

°
Which of the above investment should be undertaken in rder to maximize NPV assuming that
the project are (a) indivisible (b) divisible. • '·
Solution: .:. . -- ~,,, ···· ,- 'J ' •

(a) When Projects are Indivisible:

Criterion: Rankin based on NPV ·, Amt In Ra.
Project Cash Outflow . Cash Inflows NPV . .. Ranking baaect on
Pl
· NPV
a b c b x c =d d- b =e
1 _1,50,000 , 1.22 1,83,000 . . 33,000.. .'
2 75,000 '•' 0.95 71,250 . i · ... (3,750) ' ·:.·
3 1,75,000 1.20 2,10,000 •. ., , 35,000
4 2,25,000 · · 1.18 2,65,500 ' .. 40,500 .. ~
.5 1,00,000 1.20 1,20,000 20,000
6 2,00,000 1.05 ·2,10,000 10,000
Retained Capital = Rs. 5,00,000

Prolect
Selection of Profects
Ranking based oh NPV Cash Outflow
' . (Amt In Rs.I
NPV
4 I 2,25,000
. 40,500
3
5
II
IV
Total
1,75,000
1,00,000
5,00,000
. '
' I 35,000
20,000
95,500
Note:
'
Project 1 (Rank Ill) couldn't be sele~ed since the cash outflow is Rs. 1,50,000, whereas the
residual capital after selection of Project 4 (Rank I) and Project 3 (Rank II) is only As. 1,00,000,
Hence Project 5 (Rank IV) is selected.
(b) When Projects are Divisible: ·
Cr1'terion:
. Rank'ing based on Pl
Prolect Pl Ranklna based on Pl
1 1.22 I
2 0.95 V
3 1.20 II
4 1.18 Ill
5 1.20 II
6 1.05 IV
Retained Capital = Rs. 5,00,000
selection of Projects (Amt In Rs.
Protect
1
3
5
Ranklna based on Pl
I
II
II
Cash Outflow
1,50,000
1,75,000
-
NPV
33,000
35,000
--
4 Ill 1,00,000 20,000
*75,000 13.500 __.,,,.
Total
•working Note: 5,00,000 1 01500
Initial Outlay
2,25,000
NPV
75,000 .x 40,500

75,(XYJ x 401500
(JJ
= 2,25,000
NPV of Project 4 = Rs. 13,500
p;tal Rationing · ' " · '.t · . l'l1'1f; 14 7

tration 12: · · .:- . _.- :... ·::·'0. ·;:.~ ;. ;:.t:.;:<.:.;;:,;~·.--· ;:;.,,:::: . .:..;.~,·~::.· ·.::.:~~:, •, . (.1'.; 19'
· - · .: . , . ~ , · . , . 1. v ov. ,
X LTD. has. a capital budget ,01 R_s}:«).~,l!fl(! for tiifYt.!!/! ~ .~ore
1us 'i ;, l'
It lhe following 6
osals for which the necessa information Is here Under. · ..... .
PROPOSAL ~ (Rt .: .1 .,;, ·~ t\;... NPV (RI.) 1 ,·. /, • • , ·; > • , IRR · ( ,; ·
A . 28,00,000 ·1 • •• • • 12,00,000 ' · ·· · 20.0%
B . ·.. 10,00,000 :·i,1:•/t;1,..-l: ; ;_,r, / iii 6,40,000 · ·:·,. .. : · 17.004
1, • •

C ,.: 20,00,000 · ·. . . · .. ·."-· 8 00 00() · ,.. ,, · · · 19 0%

D · · a00000· .. ;,J:•'."_·· .L· ·: :::.1 :n ~·00·000 t: ,::: ::•·'·· '_: ; 11:so/o
, , . ., f 1, , • / t
t l I,

. ,. . . .. .
0·, ·•.·1 · 180000 0 ,,, ·. ·, ... 18.0o/o
E .·' 220000
' . '
30,00 000 , , · .. : ''
1..
,. ,. ·-10 00 000 ,..,
• .. ' ' 'L
" 12.0o/o
f

F
Find out the ranking of the proposals basect,~ ~.l;'V·~ ~!'Method. · .·.,., 1 , ••,.

lutlon:
e · ,. ·,
' 1! :, ,;:1·••\·• • '1 \,1•1·• ,l, .•1. , ' , . '. . ·1 :, ' 1{ '•.·'
,,.i i •, , . ' ;', ' ,: / , ,: 'd • I 1."/ ••• •r
::•:.J •.,:.,,...
'' • :_
\ ' i •• \ • I . \
• • ,• ·1•', 1,i ;

' • ible:I ;:•·i' ;;,i-:t"•;·

0 nkin basedonNPVwhenP 'ectsirelncflVis ' I
•,:, ,·.,
'
,·,,·,.,
'
,,·., •• ,.l , ..,

Ra osal .., ,. . NPV Rt. :••.:'"•:. ,;ro:· •. • .. ., . Rankin bued on NPV

.. .
Rationed Capital = Rs. 40,00,000 s.i.c.o., ;,i Pro ~ ,'. ,. \ ' ' ; ' :
i ·, · "'•''.,. ' · ' ~PY ~- '

based on NPV Pro ul Cash Outla~ •· • -· 1$,00,000.

I E 22•00• ·..•,· .,..'•l 6' 40 000
'
7
' '· ·., { ,••, , '' '.'., '/ ' ··10000 00 ,:····: :: I
000
IV . B .' ' ' . • I '; ' ..
' • .• , '" • -

oo,
'1,J·

' .. . : 8 00 000 ,' .. 1 • • .. ,4

V ' -28,40,000 ·
, D· 40 00 000
... ~..,, .. ,.: ,,t, . ,. ; Amt In Rs.
based on Pl when P ·ects are Divls i:~ '. ·.· ..· ..... Pl . '. , . Ranki ng~~ on Pl
Initial Outlay NPV · PV- - -::,. ,..· ,,.: ~ · · :.· ... ,~.:, ·' l·,1 ···'
!
•

., ~ ~ RHIVW•

. b C C:;·:·1.43 ;} ',L •1 ,,,i ·JV .. ·:

+ C. d i

1200 000 · , ·,,, ,., · 11 , ! 1

·~ '', ·,,...:..: ; . .._.. . V '. :
28,00,000 a'~n·ooo . ' l 18A0,000 ' ! '.~ '· :, . X1tAJI
10,00,000 •""'• I ,. :~00,000 ... ,, •,I: I, - , .. :.;' ' ··.",''. .• Ill )
8,00,000 · ..,2,'00 OOO .. .· ·/',., , ,, ,.,.i: 1.50 · , t ···,.,. ,/··· ., I'._[.)
20,00,000 OO OOO 1 , 82 . ,
8,00,000 1 4, 'ooo .. 4000,000 ,, . ..i' ...''··.., 0.87 1 . , . . . . VI
' . . ,• · •,, :·
E 2200000 8,00. .·· ··:··20'00 000 .,.:.,.
. .,. ', ;·· ,, ; ••";, ., •: ,, '
• • 0
100000 . .. , · ,, . :.-
·ldNI·~· '·
I
F 30 00 000 1 1 , • , . • • ,, • . •,

Retained C~pi~ = Rs. 40~~•~ .Se

:r ectl ' :·,, . i; ..,:-,: : -, 1 1 . .- , • ·N~V , .
· . · · .:.. lnltlll Al, 00 000
, : :18,
based on Pl 22,00,000.
I

.· P ,;,,;,• · · 640,000
I •• ,, . :'1,,1,: ' >: :, · ·,'. : .10M,QO
"t~, 1 ,,,., O :·.· ·: · .·,·.. ·. •·, '.·• •~•0000
~ 0
.
•, I '1

II a··...•. :: •: :•·.:..·~:·eooooo 00000 •• •,

· 294000 0
,,d ,, 1:•0 •\ '·•"•"
Ill '' . 40
Total
- ... -~ ••,
• ~ I I
, • •I . .. I ' ·. t \ , ;

, ) !,, :I ,I I • : ~; ' I, { '1

·.,;'
~. '
,.
• .·,. ' ; I .~. • .I~

. .

.. '
'

I, l
: ...
'
',:
,
..
'•' .. \ .- r•
 v,,.,1•,TN F/nandol M a ~ • ~
148 0

1. Points to Remembe ! I

: t· •
(I)
ictio ns on the capltaf ' - - . llt
Of putti ng restr •
(1) Capital rationing Is the process
pany. I hoos lng the mos t prof itabl e lnVNtrnenla far..._
••
Invested by the comtal ratio ning sc
(2) The criteria In capi
f lecting the mos t prof itabl e proj ects to
- . . lie
capital Investment deci sion. 58
O
(3) Capital rationing Is a strategy
h h whic h 8 limit ed capi tal bud get la ~
(')
available funds.
Capital rationing Is ~ proc
amongst between diffe rent
ess t.
proJe
'°t~g
c
in 8 way that max imiz es the ~
.

. • th amo unt of capi tal that 11 GOitg lo be

(5) wealth. itself .hm1ts. e riod whe reas hard rationing, on ...
Soft rationing is when t~e firm P8 ••
used for Investment decisions In a given time
force d by facto rs exte mal to the flnn.
othe r hand, Is the limitation on capital that Is

/fl.
Questions for Self-Practice
II II
I

I OBJECTIVE QUESTIONS I
(I) FIii In the Blanks:
ders wea lth. (Ap r/I 19)
(1) Capital rationing helps In _ _ _ _ sharehol
pany unde rtake s all pouible
(2) Shareholder wealth is maximised if a com
_ _ _ _ NPV projects.
limit on the amo unt of financt
(3) In __ __ _ capital rationing an absolute
available Is imposed. w
they are term ed as _ __
(4) When potential projects are able to be divided under
projects. ts,
her, such pn,jlcll
(5) The taking on of_ a project will preclude the taking on of anot
are called as _ _ _.
/Et 2)
; (4) Divi sible ; (5) Mut uall y ext:lu,/vl
[Ans .: (1) Max imis ing; (2) Posi tive; (3) Hard , Si,
proj ects ) Im
Tru e or False:
(11) State whe ther the follo win g stat eme nts are .
~
tal inve stme nts.
(1)Under.capita.I r~tioning there is no limit on capi ~
pany makes sure to take up onlY proie cts with
(2) In ~ap1tal rationing th~ comtmen t. '
ant1c1pate d return on inves
f h t t -lato M fiat
(3) In order to maximize shareholders' wealth ' the irm as o accep pn, r--
minimize total value added.
• • COlftl1II"
( 4) Under capital rationing in case of mutuall 1 proJ ects, the
exc us,v e
selects all projects which has a positive t Y
is used wher e there ar n~ pr~s ~nt value.
(5) Capital rationing . flOI'
1 ic1ent fund s to Invest
(6) Hard capital rationing or "external" / ~sutt n the com pellY
occurs whe
problems In raising funds in the exte;a ionin~
Fals e; ( ) F. ~al ~qui ty markets. (Oct. 18)
/Ans .: (1) Fals e; (2) Tru, ; (3) 4 .
• se, (SJ True ; (6) True}
(Ill) Match the Colu mn:
•a• ~=~~;---
~~ri~~~~~~C~o~lu~m~n~1•A~•========~~~;;;;;;~~~~2)~!!!!.!~!~
I ~1) Capital Aa11oning
(2) Soft Capital Rationing
iundl-
Column
(I) 1ndustry.w1de factors limiting
(II) Trial and Error Approach
(3) Hard Capital Rationing
(4) Divisible Projects <:~) Lim.ited capital budget.
(5) Indivisible Projects ( ) Unhmited Investment
(~) Prof_itabllity Index. .
. Skltll
1ted Man a eme nt
(Ans .:,, - Ill); (2 - VI); (3 - I); (4 - V); (5 - IIIJ~lm
 111·'. 149
~g THEOAY_ !JEB?ICN&j ,; : ···.', .. :....
. followl
Answer the . qua.a.._ :';·• , ,.. - ~ ··, ., .~.:.
(a) What ~s the ~at1onale of Clpilal 111o.·, · l._ •
1•
(b) Vv'.hat IS Capital rationing? . .· ·. 117 ·. . ,;
(c)
(d)
(e)
o,scuss the advantagee and 111•
Define capital rationing. Stalll llf
Explain the relevance of ~
.::---!'_
Clpllal rationing.
111 ':-- · · ,
t J . ....

,_
firm. (Aprll 19) . , . ~n ii In .... lliudaelng clecilloni of a'
1
Write short notes on: .1 ,,. ; : .:,_:: ; • , ·, ,: ·, r •- - , . .• •!
(a) Capital Rationing. . ,. . • . .. · .• ,. . . ~ ., ,
(b) Need for Capit8:I Rationing In lhl ffiOdlm ••· · -' .:·l :. . .' . :-· .•, . '
(c) ProcessofCapitalRationing. · · , ~ .,Jr; _._ ·1 ·: .•:;

p~~-.
,,.

(d) T)1pes of Capital Rationing. ' ·- ' .....

I PRACTICE i
. 1)
Rashtri a Manufacturi
.
ltd. fumiahaa lhe
:•
ilformallon:
Project

A 5 1.25
B 8 1.20
C 1 1.40
D 3 . 1.30
E 4 1.55
F 2 1.35
Which projects should be undertaken by the company In Older to maximise the NPV
under capital rationing, assuming that each prajlct II lndlvlllble. ltweltlnant limit Rs. 15
tacs. a

[An&: Ma,tnun NPV •Ill.I.I u P,ojflt:f8 C, D and E]

(El. 2)
Simple Company Ltd. fumishes the following lnlormnllon:
Investment limit Rs. 35 lacs.
..
Suo est the most feasible combinatiofi.
Project 11111111 OUllf NPV
In 1111111
p 21 10
4.5
a 10
3.1
A 17J
s 18 u
Q and Rare mutually exclulive. .
Assume that each project Is lndlVtl..., ....u -. 1~ •.,. 1'Ml1ofr p and OJ
{An&: Ml. 1_...,,_ .. •,.. .,, , . •.
~ . ~

standard Chemicals Ltd. furnilihll Ill

Project _tllll
!:J!IILll!!!l- -½-__.1:=ifiF--:---:-i
---77M------'--- 111
N ·Mf .·..
0 . - · .•
p
Ra k ~-~---1~~~~:C: iL' fM.. · ·
A.II n t~em on Pl and then Nllld- 1sort ._ • • • ...,., I nec1111ry an
Uon ~roiects are dlvlalb?e, 1... - fl la■ I • - • J■l1ptf • _.,..., more
0 the availability of fundl . . , . , . , P . ·
0 nce. • ·
r rJ"'rJ"'rJ"' Vipad's™ Financial Manage
/50 *~ !~ ~

Investment limit Rs. 350 lacs. ·

Rank Pro 1ect Cash Outlay (Rs. In lacs) . NPV (Ra. le
{Ans.: I p 160 . . ' . ·· 35.l(J
II N 140 · . 18.31
111 o 50 (Balance) ~
W. 1
6Q,1ZI
(Ex. 4) · .. •

.Th~ total available budget for a . company is As. 20 crore an~ the total COit,
pro1ect_1s Rs. 25 crore. The projects listed below have b_e en ranked in order of ~
!here 1s a possibility of submitting Z project where cost 1s assumed to be Rs..13 ii;;'·
rt has the rofitabilit index of 140.
Project Cost (Rs. in crores) Profitability Index= :vvo~~::~;
1~
. ..

A 6
B 5 125
C 7 1~
D 2 115
E 5 110
25
Which projects including Z should be acquired by the company?