Question Tag: Hard capital rationing

i) Soft capital rationing vs. Hard capital rationing:

• Soft capital rationing:
  This occurs when restrictions on capital allocation are internally imposed by the company’s management. It may be due to managerial decisions to control spending, budgeting constraints, or a strategic choice to limit the number of projects undertaken within a period. The firm essentially chooses to limit capital expenditures.
• Hard capital rationing:
  This happens when the company faces external constraints in raising funds from the capital market. These constraints may be due to a lack of access to external financing, high costs of borrowing, or unfavorable market conditions. The company is forced to limit its capital projects due to an inability to secure sufficient external funds.

(2 marks)

ii) Practical ways of dealing with capital rationing:

1. Delay the start of projects:
   Postpone less critical projects until funds become available or market conditions improve. This prioritizes projects with the highest returns or strategic importance.
2. Seek joint ventures:
   Enter into partnerships or joint ventures with other companies to share the financial burden of capital investments. This reduces the amount of capital required from the company.
3. Subcontract portions of investment:
   Outsource parts of the investment phase to third-party contractors who can pre-finance the work. This reduces the immediate capital requirements of the company while still allowing the project to proceed.