Lesson 5 of 7 · 12 min

Principles of capital allocation

Analyse projects on after-tax, incremental cash flows, judged broadly across the whole firm, with careful attention to when the cash arrives.

In short

Use after-tax cash flows, not accounting profit; include the tax saving from non-cash deductions such as depreciation.
Include only incremental cash flows: what changes if the project goes ahead versus if it does not.
Ignore sunk costs, money already spent or committed regardless of the decision.
Include effects on the rest of the firm: cost savings elsewhere (positive) and lost sales of existing products (negative).
Timing matters: delaying the same cash flows lowers both NPV and IRR.

Create a free account to get 7 days of full access — every lesson, video, flashcard, mock and the question bank. No card needed.