EAC and Capital Rationing

Question 1

Capital Rationing

Answer 1

Insufficient funds to fund all positive NPV projects, so capital is rationed to try and maximise shareholder value

Question 2

Hard Capital Rationing

Answer 2

Imposed by lending institutions:
Industry wide factors
Company specific:
Poor track record
Lack of assets as collateral
Poor management

Question 3

Soft Capital Rationing

Answer 3

Imposed by the own company, contrary to shareholder view:
Limited management skills
Desire to maximise return on select investments
Limited ability to gain external finance
Encourages acceptance of being sustainably profitable
Not wanting to commit to long-term projects

Question 4

Sensitivity Analysis of a DF

Answer 4

If investment is perfectly divisible by cashflow, divide it and then find the AF pct

Find the IRR, then minus off the DF given, and then divide by the DF

e.g. IRR is 18%
DF is 10%
(18-10)/10 = 80%