Capital rationing - part 1

In this lesson

1. 0:00 Capital rationing: soft versus hard constraints
2. 0:38 Divisible and indivisible projects explained
3. 2:25 Maximising NPV with limited capital
4. 3:03 Profitability index: ranking and calculation
5. 4:18 Worked example: divisible projects ranking
6. 7:03 Allocating funds by profitability index order
7. 8:51 Optimal portfolio NPV calculation

About this lesson

This video explains the two types of capital rationing—soft (internally imposed limits) and hard (actual funding shortage)—and introduces the profitability index method for ranking projects when funds are limited. You'll discover why maximising overall net present value matters when you can't invest in every positive project, and work through a practical example showing how to allocate constrained capital across divisible projects to achieve the best possible returns. Capital rationing occurs when a business has fewer funds available for investment than it would ideally like to invest. Soft capital rationing happens when senior management deliberately restricts investment spending for prudence, even though additional funds could be raised. Hard capital rationing represents a genuine shortage where raising new equity or debt finance isn't viable, forcing tough prioritisation decisions. When projects are divisible—meaning you can invest a partial amount and receive the corresponding percentage of net present value—the profitability index becomes your ranking tool. This index is calculated by dividing a project's net present value by its initial investment, showing you the NPV return per pound invested. Projects are then ranked by profitability index, with the highest-ranked projects funded first until your capital budget is exhausted. Any remaining funds can be partially invested in the next-ranked project, allowing you to maximise the combined NPV of your investment portfolio within your capital constraint.

Duration: 9m