No abstract

IntroductionThe problem of capital rationing has been treated extensively, with the focus directed primarily on two of its aspects: (a) discussion of the merits of specific measures of worth such as present worth, internal rate of return, benefitlcost ratio, etc. (Bernhard, 1971) (Grant et al., 1976) (Solomon, 1956 and (b) the development of selection procedures (Baumol and Quandt, 1965) (Bernhard, 1969) (Lorie and Savage, 1955) (Weingartner, 1963) that would maximize one such measure of worth if the decision maker had complete information about future investment opportunities and if his estimates of expected future cash flows were accurate. Much of the literature is devoted to mathematical programming procedures that optimize a single decision and, thereby, implicitly assume that the decision maker has complete information and that all projects will be converted to cash by the horizon time. Hughes and Lewellen (1974) present well reasoned arguments to support their conjecture "that mathematical programming solutions to capital rationing problems confer benefits insufficient to justify their cost and complexity in the great majority of practical applications". This article presents empirical evidence that strongly supports their conjecture.The principal advantage of such capital rationing procedures is their amenability to mathematical analysis. Their principal weakness is a lack of realism, because their formulations usually imply that cash flows are certain and treat each capital rationing decision as though it were independent of all other capital rationing decisions, thereby implicitly assuming that the decision maker has complete and certain information about investment opportunities. Such treatment ignores the fact that the current capital rationing decision is commonly one in a long sequence that started some time ago and is expected to continue indefinitely, unless halted by ruin, and also fails to recognize that the decision must be based on incomplete information and uncertain cash flows. By incomplete information we mean that the decision maker (hereafter referred to as DM) does not have, at the time of the decision, cash flow estimates for all investment opportunities that will appear between now and the horizon time for the decision, nevertheless, the current decision will affect the budgets he will have when those opportunities become known. The situation occurs when the lives of investment opportunities exceed the time between decisions.

No abstract

No abstract