Differentiate between the following: 'Capital Budgeting' and 'Capital Rationing'.

Answer 3(c) Capital budgeting and Capital Rationing Capital budgeting Capital budgeting refers to long-term planning for proposed capital outlays and their financing. It includes both raising of long-term funds as well as their utilization. It contains searching for new and more profitable investment proposals, investigating, engineering and marketing considerations to predict the consequences of accepting the investment and making economic analysis to determine the profit potential of investment proposal. There are various methods used in capital budgeting analysis such as payback period, average rate of return, net present value, internal rate of return and profitability index. Capital Rationing Capital rationing decision is a simple process in those firms where fund is not the constraint, but in majority of the cases, firms have fixed capital budget. So large number of projects compete for limited budget. So the firm rations these funds in a manner so as to maximize the long run returns. Thus, capital rationing refers to the situations where the firms have more acceptable investments requiring greater amount of finance than is available with the firm. It is concerned with the selection of a group of investment out of many investment proposals ranked in the descending order of the rate of return.