Distinguish between “Hard” and “soft” capital rationing clearly indicating the causes of each.

CPA-Financial-Management-Section-3 Revision kit

Capital rationing: a situation in which a company has a limited amount of capital toinvest in potential projects, such that the different possible investments need to be compared with one another in order to allocate the capital available most effectively.

Soft and hard capital rationing
– Capital rationing may occur due to internal factors (soft capital rationing) or external factors (hard capital rationing).
– Soft capital rationing may arise for one of the following reasons.
– Management may be reluctant to issue additional share capital because of concern that this may lead to outsiders gaining control of the business.
– Management may be unwilling to issue additional share capital if it will lead to a dilution of earnings per share.
– Management may not want to raise additional debt because they do not wish to be committed to large fixed interest payments.

– There may be a desire with the organization to limit investment to a level that can be financed solely from retained earnings.
– Capital expenditure budgets may restrict spending.
– Managers may prefer … to sudden increase in size organic (internal) growth arising from accepting several large projects especially if the firm does not want to employ new managers to manage such projects.

Hard capital rationing may arise for one of the following reasons:
– Raising money through the stock market may not be possible if share prices are depressed.
– Where the providers of equity or debt capital perceive the firm to be too risky
e.g highly geared
– Where the floatation costs of raising a small of capital is punitively high.
– Where interest rates in the economy are very high discouraging firms borrowing and using only internally available funds.

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