Chapter 8 - Capital rationing

Capital rationing comes about because:
1. There are not enough positive NPV projects
2. Companies do not always have access to all of the funds they could make use of
3. Managers find it difficult to decide how to fund projects
4. Banks require very high returns on projects
'Soft' capital rationing exists where:
1. Companies have a poor credit rating
2. Banks are unwilling to lend
3. It is difficult for the company to go to the capital markets
4. The company imposes its own rules on managers as regards the amount they can invest
Where there is single period capital rationing, the most sensible way of making investment decisions is:
1. Choose all projects with a positive NPV
2. Group projects together to allocate the funds available and select the group of projects with the highest NPV
3. Choose the project with the highest NPV
4. Calculate IRR and select the projects with the highest IRRs
Soft capital rationing exists because
1. Directors are illogical
2. There are simply not enough projects
3. Capital investment is complex and time consuming and a capital budget helps to control this
4. Banks have too much say in what goes on
Multi-period capital rationing involves:
1. The selection of packages of projects across time so as to maximise shareholder wealth
2. Convincing senior managers to relax investment rules
3. The selection of projects in each time period with the maximum individual NPVs
4. Reducing the uncertainty of decisions
A company has 3 investment opportunities as follows:
A NPV £12,000 costs £8,000
B NPV £15,000 costs £12,000
C NPV £6,000 costs £3,000
Which is the correct ranking from best to worst
1. A,B,C
2. B,C,A
3. C,A,B
4. C,B,A
Why might the ranking in 6 result in a suboptimal decision:
1. Not all items are worth investing in
2. IRR would provide a better solution
3. The selection of projects depends on the company’s broader policies
4. A higher NPV might be possible depending on the total available for investment
A company has calculated the following NPV and costs for a selection of projects. A and B are mutually exclusive, the projects are not divisible and the company has 500 available for investment
A NPV 100 cost 200
B NPV 80 cost 150
C NPV 200 cost 350
D NPV 50 cost 300
The company should invest in:
1. A and B
2. B and C
3. B and D
4. A and D
If a company is likely to be exposed to capital rationing over a number of years the opportunity cost of capital will
1. Always be the market cost of capital
2. Be a variable figure
3. The same in each period
4. The return gained from the marginal project in the rationed period
Which of the following is not an assumption of linear programming for capital rationing
1. All possible projects have been identified
2. All relationships are linear
3. All variables are divisible
4. There is no uncertainty relating to project cash flows

Chapter 8 - Capital rationing

Quiz