Lesson 5 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 5 of 8 · 16 min
Integrated case: three projects against a ROIC target
A 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.
In short
- Read the exhibit for traps in the cash flows first: sunk costs are out, lost sales on existing products (cannibalisation) are in.
- Only then run NPV and IRR against the project's required return; a positive NPV and an IRR above the required return are the same signal.
- Compute the company's ROIC with after-tax operating profit over average long-term liabilities plus equity; payables and short-term debt stay out.
- A project whose IRR is below the ROIC objective would pull company-wide ROIC down, so a management rule of "at least X%" can reject a project with positive NPV.
- Timing matters: pushing every future cash flow back lowers both NPV and IRR, and can flip a marginal project from accept to reject.
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