Capital rationing

About this lesson

You'll work through practical examples showing how to allocate capital efficiently across multiple investments, including scenarios where projects are divisible or mutually exclusive. Capital rationing occurs when organisations have limited funds to invest across multiple potential projects. Understanding whether restrictions are soft (internally imposed) or hard (externally imposed, like bank lending limits) helps explain why companies can't always pursue every positive NPV opportunity. The key decision rule remains that projects should have positive net present value, but when several positive-NPV projects compete for limited capital, you need a systematic approach to rank and select them. The profitability index is your essential tool for single-period capital rationing. Rather than simply ranking projects by highest NPV, you calculate the profitability index by dividing net present value by initial investment. This shows the return generated per pound invested, allowing you to select the combination of projects that maximises total value within your budget constraint. This technique is particularly valuable when projects are divisible, meaning you can undertake partial investments to fill remaining capital capacity. This content directly supports investment appraisal topics in FM, AFM, and APM papers, where capital rationing questions frequently appear in both objective tests and case studies.

Duration: 11m