Zero-Coupon Bonds: Pros and Cons
Zero-coupon bonds are those bonds that are sold at a deep discount to their face value. This means that these bonds do not receive any periodic interest. Instead, the investors have to invest a lump sum amount at the beginning of their investment and get paid a higher lumpsum amount at the end of their […]
Infrastructure Finance Projects: Major Sources of Funding
It is a known fact that the world is in great need of infrastructure projects and, therefore, infrastructure finance. Developing countries need to build their infrastructure for the first time. This needs to be done in order to attract more investments. However, even developed countries need to build more infrastructure projects. This is because the […]
Fixed Asset Turnover Ratio
Fixed assets i.e. property, plant and equipment represent the single largest investment any company makes in its operations. It is therefore important that a company keeps a close eye on whether these investments are performing well and generating adequate revenue and profit to justify the expenditure. While it is impossible to come up with a […]
History of Accounting
One can never really understand a subject, unless they know where it came from. Therefore, a short history of the subject of accounting may be of interest to students of accounting. Here is a very brief history of how accounting evolved: Single Entry Accounting System Accounting is as old as financial transactions themselves. As soon […]
Intrinsic Value and Mispricing
The whole objective of equity valuation is to find mispriced securities. Investors can make abnormal profits when they find securities which are lower than their intrinsic worth trading in the market. However, the concept of mispricing and intrinsic value is misunderstood to say the least. What the average person considers as mispricing is at best […]
As discussed in the previous article, capital rationing is a form of capital budgeting. In capital rationing we change the unlimited capital assumption of capital budgeting and we try to choose projects with the finite capital that we have on hand. This finite capital may be in the form of capital that the firm already has or it may be in the form of a decision to raise a limited amount of capital in the future. Either way, the amount of capital available at the company’s disposal for decision making is finite and it is known. There are two types of capital rationing. They have been explained in this article:
Soft rationing is when the firm itself limits the amount of capital that is going to be used for investment decisions in a given time period. This could happen because of a variety of reasons:
This type of rationing is called soft because it is the firm’s internal decision. They can change or modify it in the future if they think that it is in their best interest to do so.
Also, companies usually implement this kind of rationing on a department basis. From a master investment budget, departmental investment budgets are drawn and each department is asked to choose projects on the basis of funds allocated. Only in case of an extremely attractive project are the departmental restrictions on capital investments compromised.
Hard rationing, on the other hand, is the limitation on capital that is forced by factors external to the firm. This could also be due to a variety of reasons:
So hard rationing arises because of market imperfections and because of limitations created by external parties.
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