Capital Rationing

calender iconUpdated on February 23, 2024
corporate finance and accounting
financial ratios

Capital rationing is a situation in which a firm is unable to obtain all of the capital it needs to finance its investment projects. This can occur when there is a shortage of available capital, or when the cost of capital is high.

Causes of Capital Rationing:

  • Shortage of available capital: When there is a shortage of available capital in the market, firms may be unable to obtain all of the capital they need.
  • High cost of capital: When the cost of capital is high, firms may be unwilling to borrow as much money.
  • High interest rates: When interest rates are high, firms may be more likely to invest in projects that have a lower return on investment.

Effects of Capital Rationing:

  • Limited investment: Capital rationing can limit the amount of investment that firms can make.
  • Higher cost of production: Capital rationing can lead to a higher cost of production for firms, as they may be forced to use less efficient equipment or technologies.
  • Lower returns on investment: Capital rationing can lead to lower returns on investment, as firms may be forced to invest in projects that have a lower return on investment.

Examples of Capital Rationing:

  • A firm is unable to obtain all of the capital it needs to build a new factory.
  • A firm is unwilling to borrow money at a high interest rate because the cost of borrowing is too high.
  • A firm invests in a project that has a low return on investment because the firm is unable to find other investment options.

Policy Responses to Capital Rationing:

  • Government intervention: Governments can intervene in capital rationing by providing subsidies for investment or by regulating interest rates.
  • Private sector initiatives: Firms can take steps to reduce their need for capital, such as by increasing their use of technology or by outsourcing production.

Conclusion:

Capital rationing is a situation in which a firm is unable to obtain all of the capital it needs to finance its investment projects. It can be caused by a shortage of available capital, a high cost of capital, or high interest rates. Capital rationing can have a number of negative effects on firm performance, including limited investment, a higher cost of production, and lower returns on investment.

FAQ's

What is capital rationing with an example?

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Capital rationing limits investments due to scarce funds. For example, a company with $1 million may choose only the most profitable projects if it needs $2 million for all options.

What does capital rationed mean?

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Which technique is used for capital rationing?

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What is rationing of credit with an example?

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What are the advantages of capital rationing?

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