Abstract
The definition of net present value implies that the reinvestment rate of return on the intermediate cash flows is equal to the risk-adjusted discount rate of the project. However, in many situations, the two rates are different. Therefore, in capital rationing, the ranking of projects based on net present value is incorrect in those situations. Another problem is that financial managers would prefer to use internal rate of return for ranking, although ranking by net present value is theoretically superior. This paper solves both problems by developing a new ranking criterion.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Ariel, Robert. 1998. “Risk Adjusted Discount Rates and the Present Value of Risky Costs”.The Financial Review 33: 17–30.
Brigham, Eugene F., and Louis C. Gapenski. 1993.Intermediate Financial Management. 4th ed. New York: Dryden Press.
Emery, Douglas R., and John D. Finnerty. 1993.Principles of Finance with Corporate Applications. New York: West Publishing.
Gitman, Lawrence J. 1995.Foundations of Managerial Finance. 4th ed. New York: Harper Collins.
Kim, Chang-Soo, David C. Mauer, and Ann E. Sherman. 1998. “The Determinants of Corporate Liquidity”.Journal of Financial and Quantitative Analysis 33: 335–359.
Pinches, George E. 1994.Financial Management. New York: Harper Collins.
Shapiro, Alan C. 1996.Modern Corporate Finance. New York: Macmillan.
Weston, J. Fred, and Thomas E. Copeland. 1992.Managerial Finance. 4th ed. New York: Dryden Press.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Wong, H.T. Capital rationing: The general case and a better criterion for ranking. J Econ Finan 24, 90–96 (2000). https://doi.org/10.1007/BF02759698
Issue Date:
DOI: https://doi.org/10.1007/BF02759698