Capital rationing occurs when:

Capital rationing occurs when a firm faces limitations on the amount of capital it can expend on investments, despite having potentially attractive projects available. This situation arises when a firm lacks sufficient capital—whether due to budget constraints, cash flow limitations, or other financial restrictions—to fund all investment opportunities that meet its return criteria.

When capital is rationed, firms must prioritize their projects based on expected returns, risk levels, and alignment with strategic goals. As a result, they may only pursue those projects that offer the best potential for profitability given the financial resources they have available. This contrasts with scenarios where a firm has ample resources to invest in all viable projects or has guaranteed access to funding; in such cases, capital rationing would not be an issue.