Capital Rationing

• Soft Rationing - Internal limit on capital expenditure
• Hard capital Rationing - Imposed by financial organization

Ranking NPV projects based upon profitability index is one way to maximize the capital

eg Take the PV (not netted by the initial investment) and divide it by the investment, so if PV = 3.25 and Investment was 2.5 then the profitability index is 1.3. Do that for all projects and undertaken all the projects up to the capital limit. IN THE NOTES THE NPV IS USED AND WILL NOT AFFECT THE RANKINGS

• Projects do all start at the same time so it is difficult to identify a specific capital amount
• The NPV's may any differing income streams and risks
• If the investment outlays are above the capital limit you may have to undertake only part of the project if that is feasible or the number of whole projects that most closely utilizes the capital. See NPV

If there are mutually exclusive projects, for instance you cannot do E if you do C then pursue the projects based upon the profitability index up to the Capital Rationing limit. There all combinations should be tried to determine the best combination. However, the combination must exactly equal the capital rationing limit.