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CA Final · Advanced Financial Management · Advanced Capital Budgeting Decisions

Which of the following is an example of external (hard) capital rationing rather than internal (soft) rationing?

Banks refusing to lend beyond a fixed limit is external or hard capital rationing, because the constraint is imposed by the capital market. Spending caps, dilution avoidance and payback hurdles are decided internally by management, so they are soft rationing.

  1. ABanks refuse to lend the firm more than ₹50 crore in a year despite many positive-NPV projectsCorrect
  2. BThe head office sets an annual spending cap of ₹5 crore for each division
  3. CManagement declines to issue new equity to avoid diluting promoter control
  4. DThe board requires a payback of under three years for any new project

Explanation

Hard rationing arises from outside the firm, such as lenders or markets limiting the funds available. Divisional caps, a decision not to dilute control and payback hurdles are all set by management itself, so they are soft rationing.

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