Capital Investments and Capital Allocation

How companies spend money on long-lived assets and decide which projects deserve it: the four types of capital investment, the capital allocation process, how to compute and interpret NPV, IRR and ROIC, the principles that keep project analysis honest, the cognitive and behavioural pitfalls analysts should watch for, and the real options that give management flexibility after the first decision.

1. 1. Types of capital investmentsCapital investments are long-lived assets bought to keep the business running or to grow it, and their risk rises as the project moves further from what the company already does.Free12 min
2. 2. The capital allocation process and NPVCapital allocation picks the projects that add the most value after the opportunity cost of capital, and NPV measures that added value in currency.Video · 6 min14 min
3. 3. IRR, and choosing between IRR and NPVThe IRR is the discount rate that makes NPV zero; it is a handy percentage, but when it conflicts with NPV, NPV wins.Video · 6 min13 min
4. 4. Return on invested capital (ROIC)ROIC is the company-wide return on all the long-term capital management has invested, and outsiders can calculate it from published statements.Video · 6 min13 min
5. 5. Integrated case: three projects against a ROIC targetA project can add value (positive NPV) and still fail management's ROIC objective, so a full capital-allocation case chains four steps: clean the cash flows, run NPV and IRR, compute the company's ROIC, then test each project against the ROIC floor.16 min
6. 6. Principles of capital allocationAnalyse projects on after-tax, incremental cash flows, judged broadly across the whole firm, with careful attention to when the cash arrives.12 min
7. 7. Capital allocation pitfallsEven with good tools, capital allocation goes wrong through cognitive errors in the analysis and behavioural biases in judgement, and analysts can spot many of them from outside.13 min
8. 8. Real optionsReal options give management the right, but not the obligation, to change a project later, and that flexibility can turn a rejected project into an accepted one.Video · 6 min13 min