A ﬁrm that faces capital rationing must select a subset of capital projects based on some ranking criterion. The capital budgeting technique best suited for this is the __________.
A) NPV
B) IRR
C) PI
D) AAR
E) payback

Question

Quizplus · Accepted Answer

The capital budgeting technique that is best suited for firms facing capital rationing is the profitability index (PI). The PI enables firms to rank projects based on their profitability per dollar invested, which is particularly important when there are constraints on available capital. By choosing projects with the highest PI, firms can maximize their return on investment given the limited resources available. NPV, IRR, and AAR are all useful capital budgeting techniques, but they do not specifically address capital rationing issues. Payback period is generally not recommended as a primary selection criteria since it ignores the time value of money.

A ﬁRm That Faces Capital Rationing Must Select a Subset