When hard capital rationing exists, projects may be accurately evaluated by use of:
A)Payback period
B)Mutually exclusive IRRs
C)A profitability index
D)Borrowing, rather than lending, projects

Question

Quizplus · Accepted Answer

When hard capital rationing exists, the company has limited financial resources to invest in projects, and only the projects with the highest return on investment can be considered for funding. The profitability index (PI) is the ratio of the present value of expected cash flows to the initial investment, and it measures the value a project creates per unit of investment. Using the PI method can ensure that only the projects that generate the highest value will be selected, and the company can make the most efficient use of its limited capital. The payback period and mutually exclusive IRRs methods do not adequately consider the time value of money, and borrowing rather than lending projects may not be a feasible option if the company already has high levels of debt.

When Hard Capital Rationing Exists, Projects May Be Accurately Evaluated