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.
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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.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved
capital rationinga 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.
Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson