This module is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 9 of 10 · 15 min
Capital investments and capital structure
Start by mapping where capital came from and where it went, then judge whether investments earned more than the cost of capital (ROIC vs WACC) and how much risk the capital structure adds (leverage, coverage, DFL), tying it together with the ROE decomposition.
In short
- The first step is to determine historical sources and uses of capital: operating cash flow (incl. negative NWC), debt and equity issues and asset sales vs cash build-up, positive NWC, capex, acquisitions, debt paydown, dividends and buybacks.
- Value is created when ROIC exceeds WACC over the long run. Outside analysts lack project-level IRRs and NPVs, so they use these aggregate measures and their trends.
- Capital structure risk: leverage and coverage ratios (net debt / EBITDA, EBIT / interest), credit ratings and the degree of financial leverage: DFL = %Δ net income / %Δ operating income.
- DOL and DFL together make up total leverage: a company with high operating leverage may sensibly avoid much financial leverage.
- ROE = tax burden × interest burden × EBIT margin × asset turnover × equity multiplier: high turnover and leverage can turn thin margins into a high ROE.
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