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Capital Rationing (Single Period) (Investment of surplus funds (Key factor…
Capital Rationing (Single Period)
Definition
Unable to invest all +NPV projects
Not maximize sharehold wealth
General Rule
NPV
Maximize the value of a company
Maximinze the wealth of ordinary shareholders
secure maximum return = maximum overall NPV
IRR
How?
Divisable projects
What is it?
Make Partial Investment
Gain pro rata NPV
eg: land
Ranking projects based on PI
PI -> Investing sequentially (assume project is non-repeatable)
How to calculate?
NPV/Initial investment
Note: Limiting factor analysis
Non-divisable projects
What is it?
Invest full amount
Eg: oil refinery
Rules:
NPV from different combinations of projects
Note: surplus funds
Ignore Return from investing surplus funds
Investment of surplus funds
Non-divisible projects
Ignore return from investing surplus funds
Invest in money market
Key factor: Good working capital management to maximize return
Why??
Cash shortages
High inflation
Fail to generate sufficient funds
Finance expansion (Growth)
Seasonal / cyclical
Large one-off item of expenditure
Property purchase
Loss making
Reasons
Soft capital rationing
Not issue stocks
Dilute EPS
Potential acquirer
Not wish to more debt
Fixed interest payments
Poor/challenging economic prospects
High existing debt obligations
Organic growth
RE
BOD create an Internal market for capital investment funds
What is internal market?
accept robust capital investment projects
reject marginal capital investment projects
Hard capital rationing