capital rationing

Capital rationing

Placing limits on the amount of new investment undertaken by a firm, either by using a higher cost of capital, or by setting a maximum on the entire capital budget or parts of it.

Capital Rationing

The act or practice of limiting a company's investment. That is, capital rationing occurs when a company's management places a maximum amount on new investments it can make over a given period of time. The two methods of capital rationing are forbidding investments over a certain amount or increasing the cost of capital for such investments. Capital rationing is most common when a company's previous investments have not performed well.

capital rationing

a situation where a firm selects an annual capital budget which is less than the amount required to undertake all INVESTMENTS promising a rate of return in excess of the cost of capital. For example, if a firm requires a minimum 20% return on any investment then all of the appropriate investment opportunities available to the firm which promise a return of 20% or more may involve a total expenditure of, say, £10 million. However, if the firm decides that it is willing to spend only £6 million, then it must rank investment opportunities in descending order of rate of return, undertaking those with the highest promised return and rejecting others even though the latter opportunities promise a re- turn greater than the 20% cost of capital. The firm is said to be in a situation of capital rationing because it is investing less than the amount dictated by usual profit maximizing criteria. See CAPITAL BUDGETING, INVESTMENT APPRAISAL.
References in periodicals archive ?
In "The Effect of Financing Sources on the Usefulness of Financial Reporting Quality in Guiding Investments," Kevin Sun shows that ineffective monitoring and capital rationing by shareholders and banks, due to information asymmetry, may result in a lack of management's investment responses to changes in growth opportunities.
Credit committees were often approving only 25 per cent of viable applications due to capital rationing and taking a very selective stance.
The continued impact of that capital rationing can be seen even now as some of the UK's biggest banks withdraw from parts of the SME lending market such as asset finance.
A company may adopt a posture of capital rationing because it is unwilling to use external sources of financing for its capital expenditures.
The case provides an opportunity to consider the effects of capital rationing.
IRR has also been criticised because it doesn't always correctly evaluate mutually exclusive projects or ensure the best allocation of resources when capital rationing occurs.
The impact of liability risk on the cost of capital can be significant and may lead to capital rationing.
While it is typically assumed that all value-generating projects should be accepted, Shapiro addresses the important issue of limited project choice due to capital rationing or mutual exclusivity in the chapter's appendix.
It shows that such programs may, in addressing information deficiencies, serve to uncover various other barriers such as constrained information flows within firms and capital rationing.
Such underinvestment, or capital rationing, as a result of adverse selection is consistent with shareholders curtailing informational rents earned by their privately informed managers at the expense of reduced efficiency (e.
Successful financial managers must arrange funding from various sources, some of which are not traditional lenders; consider strict capital rationing for new capital projects; ally with partners to meet the company's strategic mission; and be prepared to motivate credit sources with equity sweeteners.
On the topic of planning he talks about capital rationing and shows how a nine-step Heuristic approach works in the process of selecting a project from a list of several.

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