Page 47 - AFM Integrated Workbook STUDENT S18-J19
P. 47

Investment appraisal






                           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.










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