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Chapter 26: Q3RQ (page 1463)

What is capital rationing?

Short Answer

Expert verified

Method of awarding capital in most profitable way among the different project is called capital rationing.

Step by step solution

01

Meaning of Capital rationing

Capital rationing may be a well-thought-out approach utilized by businesses to confine the number of projectsthey take on at any given moment, permitting proprietors and administration to aim for strong and profitable activities, permitting them to produce superior benefits inside a restricted capital budget.

02

Explaining the capital rationing

The practice of assessing and selecting among potential capital projects depending on the accessibility of cash is known as capital rationing. Capital rationing happens when a company's cash accessible to spend on long-term resources is confined. Managers must choose whether and when to create certain capital investments.

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Most popular questions from this chapter

Refer to Short Exercise S26-4. Continue to assume that the expansion has no residual value. What is the project’s IRR? Is the investment attractive? Why or why not?

S26-6 Using the ARR method to make capital investment decisions Refer to the Hunter Valley Snow Park Lodge expansion project in Short Exercise S26-4. Calculate the ARR. Round to two decimal places.

Describe the capital budgeting process.

Outlining the capital budgeting process Review the following activities of the capital budgeting process: a. Budget capital investments. b. Project investments’ cash flows. c. Perform post-audits. d. Make investments. e. Use feedback to reassess investments already made. f. Identify potential capital investments. g. Screen/analyze investments using one or more of the methods discussed. Place the activities in sequential order as they occur in the capital budgeting process.

Hill Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of\(8,700,000. Expected annual net cash inflows are \)1,550,000 for 10 years, with zeroresidual value at the end of 10 years. Under Plan B, Hill Company would open threelarger shops at a cost of \(8,340,000. This plan is expected to generate net cash inflowsof \)990,000 per year for 10 years, the estimated useful life of the properties. Estimatedresidual value for Plan B is $1,200,000. Hill Company uses straight-line depreciationand requires an annual return of 10%.

Requirements

1. Compute the payback, the ARR, the NPV, and the profitability index of thesetwo plans.

2. What are the strengths and weaknesses of these capital budgeting methods?

3. Which expansion plan should Hill Company choose? Why?

4. Estimate Plan A’s IRR. How does the IRR compare with the company’s requiredrate of return?
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