CAPITAL RATIONING

SWARNAM SCAPITAL RATIONINGINTRODUCTIONCapital rationing situations arises when a firm operates within a fixed budgetIt other words, it means the selection of only some of the profitable investment proposals and the rejection of others profitable investment proposals due to limited availability of fundsTYPES OF CAPITAL RATIONINGHard Capital Rationing - A capital budget to which a company must adhereSoft Capital Rationing - limits based on the judgments of senior managementREASONS FOR CAPITAL RATIONINGExternal Reasons : Imperfection of capital market informationis notquickly disclosed to all participants init and where the matching ofbuyers and sellers isn't immediateInternal Reasons : Company constraintsSteps in Capital RationingRanking of the different investment proposalsSelection of some of the profitable investment proposals -- divisible project (project which can be accepted in parts) -- indivisible project (project which can be accepted or rejected entirely)INFLATION AND CAPITAL BUDGETINGFall in the value of moneyFor Example: A person would like to buy 1 kg of apple with Rs.100. Now when the inflation rate is 5% then the person would require Rs.105 to buy the same quantity of applesInflation is of expected inflation and unexpected inflationExpected inflation is where the manager anticipatesUnexpected inflation refers to the difference between actual and expected inflation

Inflation and Cash FlowsEstimating the cash flows is the first step for selecting the proposalsDetermine cost and benefitsEffects on Inflation on Cash FlowsDiscounting Cash Flow is generally expressed in nominal termsIt would be inappropriate to use nominal rate which are not adjusted for impact of inflationReal Rate of Return should be determinedInflation and Discount RateThe Discount rate has become one of the central concepts of financeIt is greatly influenced in calculating NPVEffects of Inflation on Discount Rate:To be consistent and free from bias, the cash flow should match with the discount rate.ImplicationsThe output price should be higher than the expected rate of returnIf the company is not able to raise the output price, it can make some internal adjustments in working capitalThe adjustments should be made through capital structure