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Capital Rationing

Capital Rationing

Capital Rationing can be divided into following two categories:

(a) Hard Capital Rationing

(b) Soft Capital Rationing

(a) Hard Capital Rationing: Hard capital rationing is a situation related to external sources. Agencies either capital market itself of Government (may or may not act through Capital Market) will supply only limited amount of capital in spite of fact the projects with positive NPVs have been identified. This situation implies existence of imperfect capital market as in perfect capital market hard capital rationing should never be occurred.

(b) Soft Capital Rationing: Soft Capital Rationing is due to internal forces such as limits imposed by management on capital expenditure. There may be many reasons for such imposition some of which are as follows:

• In order to retain control senior management may place limits.

• Although some ambitious managers may be interested to overstate the extent  of investment opportunities in their sector of responsibility. But their individual evaluation to sort out good project shall be time consuming and bureaucratic.

• Even though the firm may be operating in a dynamic environment and have a large number of profitable expansion opportunities. However, accepting all of them may lead to difficulties in planning and control.

• Management may be worried about the increasing risk associated with extensive borrowings and asset levels.

• Existing owners, managers and family shareholders may not be interested in losing control by way of issuing additional equity to meet the requirement of finance.

Capital rationing may also be introduced by following the concept of ‘responsibility accounting’, whereby management may introduce capital rationing by authorizing a particular department to make investment only up to a specified limit, beyond which the investment decisions are to be taken by higher-ups.

In capital rationing it may also be more desirable to accept several small investment proposals than a few large investment proposals so that there may be full utilisation of budgeted amount.

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