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Capital rationing has to do with the acquisition of new investments. More to the point, it is all about getting investments based on such factors as the recent performance of other capital investments, the amount of disposable resources that are free to acquire a new asset, and the anticipated performance of the asset. In short, it's a strategy employed by companies to make investments based on the current relevant circumstances of the company.
Generally, capital rationing is used as a means of putting a limit or cap on the portion of the existing budget that may be used in acquiring a new asset. As part of this process, the investor will also want to consider the use of a high cost of capital when thinking in terms of the outcome of the act of acquiring a particular asset. Any responsible company will likely choose to employ strategies that support the productive use of disposable funds built within a capital budget, but at the same time, it is important to understand what benefits can reasonably be expected from owing the asset in question.
Since this strategy is all about setting criteria that any investment opportunity must meet before the company will seriously entertain the purchase, many businesses choose it as their guiding process for any acquisitions. Using the basic principles of the technique, a company can develop a list of standards that must be addressed before any capital purchase. If the standards are drafted in a manner that accurately reflects the current condition of the company, then there is a good chance the right types of investments will be considered.
Some of the more important factors to consider as part of a productive capital rationing approach are the financial condition of the company, the long and short term goals of the business, and proper attention to daily operations. One of the benefits of the strategy is that the approach helps to ensure that funds for basic operations are not diverted in order to take advantage of a so-called “can’t fail” opportunity, which helps to maintain the stability of the business.
Which project should be selected under capital rationing?