Page 38 - Microsoft Word - 00 P1 IW Prelims.docx
P. 38

Chapter 2





                           Capital rationing





               5.1   Introduction to capital rationing

               Shareholder wealth is maximised if a company undertakes all available positive NPV
               projects. Capital rationing is where there are insufficient funds to do so.




                                                Capital rationing







                                 Single period                      Multi-period







                  1  Calculate the profitability index (PI) for each
                    project
                    i.e. NPV / Capital invested

                  2  Allocate available finance to the projects with
                    the largest PI



                 Allocate available finance using linear programming. To formulate a linear
                  programme:


                  1  Define unknowns (e.g. Let x = proportion of Project X undertaken, y =
                    proportion of Project Y undertaken etc)
                  2  Formulate objective function (maximise NPV)

                  3  Express the given constraints as inequalities.









               26
   33   34   35   36   37   38   39   40   41   42   43