Tuesday, 3 November 2015

Single Period Capital Rationing

Single Period Capital Rationing

Single period Capital Rationing meaning the shortage of capital for one year only, normally this year is the initial year e.i. Year 0. Single Period capital rationing can be analyzed in term of divisible and non divisible project.

Single Period Rationing for Non Divisible Projects

A project which cannot be undertaken partially is known non divisible projects. For example construction of a bridge is a non divisible project, one cannot construct half bridge. Divisibility of project is normally decided by nature of project or agreement of project.

Selection of Non Divisible Projects

Selection of non divisible project may be analyzed in the following stages or steps i.e. NPV maximization objective, different combination analyses, selection of maximum contributing combination.

a.    NPV Maximization
NPV maximization is the objective, and projects are to be selected on the bases of these basic selection criteria. it is important to remember that NPV maximization is basic principal for both divisible and non divisible projects .

b.    Different Combination
Different combination of projects are formed and analyzed in terms of total NPV contribution by these projects and funds exhaustion by these projects.

c.    Maximum Contributing Combination
Maximum contributing combination is selected. It is important to remember that maximum contributing combination must be within range or feasible i.e. funds are available for undertaken theses projects.

Single Period Capital Rationing Example
ABC companies has option to undertake four project, which are divisible in nature, and total Fund Available are 32 million . Suggest which of following projects should be undertaken

Project
Finance Required
NPV
A
   10
4
B
    8
3
C
   12
5
D
   20
7

Solution
1.    Ranking of Project
Project
Funds
NPV
A+B+C
10+8+12 = 32
4+3+5= 12
A+C+D
10+8+20= 40
Not possible
A+D
10+20   = 30
4+7= 11
B+D
8+20      =28
3+7= 10
C+D
12+20 =32
5+7 =12