Types of Capital Rationing
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 companys 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 firms 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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