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CA Final · Advanced Financial Management · Advanced Capital Budgeting Decisions

Which statement best describes capital rationing in capital budgeting?

Capital rationing means the firm has a limited capital budget, so it cannot accept all positive-NPV projects. It must pick the combination that gives the highest total NPV within the available funds, instead of simply accepting every project that looks acceptable.

  1. AA firm has limited funds and must choose among positive-NPV projects to maximise total NPVCorrect
  2. BA firm accepts every project whose IRR exceeds the risk-free rate
  3. CA firm rejects all projects with a payback period beyond one year
  4. DA firm raises unlimited funds at its weighted average cost of capital

Explanation

Capital rationing arises when funds are limited, so not all positive-NPV projects can be taken. The objective is to select the combination that maximises total NPV within the budget. Unlimited funding at WACC describes the absence of rationing.

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