Capital rationing

Capital rationing arises when positive-NPV projects exceed available funds, requiring prioritisation. Under single-period rationing, the profitability index — NPV per euro invested — maximises total value within the budget constraint.

ByHoang TruongUpdated July 2, 2026

FrameworkDCF investment appraisal

See it move

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With a €200,000 capital budget, ranking three projects by profitability index rather than NPV changes the answer. Project B (PI 0.35, cost €100,000) and Project C (PI 0.30, cost €80,000) together use €180,000 and generate €59,000 of NPV, leaving €20,000 unallocated — more value than funding Project A alone, which would generate only €45,000.

Where it fits

TopicCapital Budgeting & Investment AppraisalAdvancedSubjectCorporate FinanceAdvanced

The formula

LaTeX

PI = \frac{NPV}{I_0}

Variables

$P I$: Profitability index: net present value generated per unit of capital invested
$N P V$: Net present value of the project
$I ni t ia l in v es t m e n t$: Capital outlay required at the start of the project (I₀)

Under single-period capital rationing, rank projects from highest to lowest PI and select down the list until the budget is exhausted. This maximises total NPV per unit of scarce capital.