Capital Rationing: Capital Rationing is the process of allocation of amount to be invested in the project. Capital Rationing is done using the methods of capital budgeting. Some of those methods as are as follows: Payback Period: Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project. The formula to calculate the Payback period is as follows: P a y b a c k P e r i o d = I n i t i a l I n v e s t m e n t A n n u a l C a s h inf l o w Hence, smaller the payback period better it is. A project with the smaller payback period is chosen first in the capital rationing process. ARR: Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment. The formula to calculate ARR is as follows: A R R = A v e r a g e A c c o u n t i n g p r o f i t s A v e r a g e I n v e s t m e n t Hence, higher the ARR better it is. A project with the Higher ARR is chosen first in the capital rationing process. NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment.. The formula to calculate the NPV is as follows: N P V = P r e s e n t v a l u e o f c a s h i n f l o w s – P r e s e n t v a l u e o f c a s h o u t f l o w s A project should be accepted if it has a positive NPV. Hence, higher the NPV better it is. A project with the Higher NPV is chosen first in the capital rationing process. To Choose: The true statements about the capital rationing decisions

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Chapter 26, Problem 6QC

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Introduction:

Capital Rationing: Capital Rationing is the process of allocation of amount to be invested in the project. Capital Rationing is done using the methods of capital budgeting. Some of those methods as are as follows:

Payback Period: Payback period is the period in which the project recovers its initial cost of the investment. It can be calculated by dividing the initial investment by the annual cash inflow from the project. The formula to calculate the Payback period is as follows:

$P a y b a c k P e r i o d = \frac{I n i t i a l I n v e s t m e n t}{A n n u a l C a s h \inf l o w}$

Hence, smaller the payback period better it is. A project with the smaller payback period is chosen first in the capital rationing process.

ARR: Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

$A R R = \frac{A v e r a g e A c c o u n t i n g p r o f i t s}{A v e r a g e I n v e s t m e n t}$

Hence, higher the ARR better it is. A project with the Higher ARR is chosen first in the capital rationing process.

NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment.. The formula to calculate the NPV is as follows:

$N P V = P r e s e n t v a l u e o f c a s h i n f l o w s - P r e s e n t v a l u e o f c a s h o u t f l o w s$

A project should be accepted if it has a positive NPV. Hence, higher the NPV better it is. A project with the Higher NPV is chosen first in the capital rationing process.

To Choose: The true statements about the capital rationing decisions

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