Lesson 2 of 8 · All lessons in this module
- Types of capital investments
- The capital allocation process and NPVVideo lesson
- IRR, and choosing between IRR and NPVVideo lesson
- Return on invested capital (ROIC)Video lesson
- Integrated case: three projects against a ROIC target
- Principles of capital allocation
- Capital allocation pitfalls
- Real optionsVideo lesson
Lesson 2 of 8 · 14 min
The capital allocation process and NPV
Capital allocation picks the projects that add the most value after the opportunity cost of capital, and NPV measures that added value in currency.
In short
- Capital allocation is how management and the board decide where to invest capital and when to return it; it aims for risk-adjusted returns above what investors could earn elsewhere.
- Four steps: idea generation → investment analysis → planning and prioritisation → monitoring and post-investment review.
- NPV = present value of expected after-tax cash flows, discounted at the required rate of return, minus the investment cost.
- Rule: invest if NPV ≥ 0. A positive NPV is necessary but not sufficient: other projects, constraints and strategy also matter.
- If no value-creating projects remain, the capital should be returned to shareholders.
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