## Capital Budgeting Under Capital Rationing

Normally, every project with a positive NPV should be accepted to maximise shareholders' wealth. But capital rationing occurs when limited capital forces a firm to choose among several projects that all have positive NPVs.

The correct selection method depends on whether projects are divisible:

### Case 1 — Projects are Independent AND Divisible

You can invest in a fraction of a project. Here the simple NPV rule is modified:

Rank projects by NPV per rupee of capital invested (a profitability-per-rupee basis).
Allocate the limited budget to the highest-ranked projects first, using fractions where needed to exhaust the budget.

### Case 2 — Projects are NOT Divisible

You must take a project whole or not at all. Here:

Rank by absolute NPV, and
Try combinations of projects, mixing them up to the point where the available capital is exhausted, choosing the combination giving the highest total NPV.

> Key distinction: Divisible → rank by NPV per rupee. Indivisible → maximise total NPV across feasible combinations.

⚠️ Common exam mistakes

Using plain NPV ranking for divisible projects — under rationing of divisible projects you must rank by NPV per rupee of capital, not absolute NPV.
Trying to take fractions of indivisible projects — when projects can't be split, you must compare whole-project combinations that fit the budget.
Forgetting that all the candidate projects already have positive NPV; rationing is about selecting among good projects, not rejecting bad ones.

Reference:

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