Question

(iii). Vito had the opportunity to source further finance which could have meant they bought the two pieces of machinery however their board have rationed the amount of capital available for investment this year to €600,000. This is an example of what type of capital rationing and why might they have done this?

Answer 1

Capital Rationing: Capital rationing is a strategy used by companies or investors to limit the number of projects they take on at a time. If there is a pool of available investments that are all expected to be profitable, capital rationing helps the investor or business owner choose the most profitable ones to pursue. There are two types of capital rationing Soft and Hard.

Soft rationing refers to a situation where a company has freely chosen to impose some restrictions on its capital expenditures, even though it may have the ability to make much higher capital investments than it chooses to.

Hard rationing results from external constraints beyond its control. A very common example of hard rationing is capital expenditure limitations imposed by lenders upon borrowers

In our case, soft capital rationing has been done and the possible reason could be:

(i) To be ready for future opportunities, such as a project with a better return rate or a reduction in capital cost. There is a conscience in the preservation of some capital for such future scenarios.

(ii) Board might want to limit the exposure to external finance

(iii) Capital investment incurs risk. Any project can potentially fail, resulting in a loss. Perhaps you do not wish to expose your business to a higher degree of risk than it already has.