FRM: Capital allocation

Explanations, applications and practice for capital allocation.

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  Incremental project cash-flow bridge

  Download a dated CSV separating operations, equipment, balance funding and closing amounts.

  Templates

• An indivisible-budget ratio counterexample

  Inspect every subset rather than assuming the highest ratio gives the best allocation.

  Worked examples
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  Capital-budget combination calculator

  Compare all subsets of up to twelve independent indivisible projects under one initial budget.

  Tools

• Lost sales and lost contribution

  Use the cash-flow effect of displaced activity rather than automatically subtracting its gross revenue.

  Concepts

• Building a capital-allocation analysis work sample

  Show a documented cash-flow bridge, a constrained comparison and a numerical quality check.

  Careers

• Incremental operating cash-flow bridge

  Subtract baseline receipts and cash costs from the proposal’s corresponding amounts.

  Formulas

• Building an incremental project cash-flow model

  Define the alternative, dates and cash-flow boundary before calculating value.

  Lessons

• Checking a reported project IRR ranking

  Substitute a reported return into the original cash-flow equation before interpreting a comparison.

  Worked examples

• Comparing projects under explicit constraints

  State exclusivity, funding, timing and model scope before interpreting a ranking.

  Lessons

• Accounting profit and project cash flow

  Reconcile an operating earnings figure before using it as a dated cash flow.

  Comparisons

• Independent and mutually exclusive projects

  Define whether projects can be selected together before ranking their results.

  Concepts

• Owned-building and external-lease alternatives

  Compare separate arrangements without charging both alternatives to one branch.

  Worked examples

• Subtracting an outlay from an already net NPV

  Check whether a supplied amount is gross present value or already net of the investment.

  Common mistakes

• Simplified operating cash flow and a depreciation tax shield

  Reconcile accounting operating profit with cash under explicitly immediate tax assumptions.

  Formulas

• Owned assets and alternative use

  Identify a forgone alternative rather than treating ownership as free access.

  Concepts

• Payback recovery and project value

  Compare a recovery statistic with the full-horizon discounted sum.

  Comparisons
• 

  Payback and discounted-recovery calculator

  Inspect end-period recovery, interpolation and the full entered-horizon NPV.

  Tools

• Gross and net profitability-index ratios

  Match a threshold and reported number to the stated ratio convention.

  Comparisons

• Profitability-index conventions

  State whether the numerator is gross receipt PV or net project NPV.

  Formulas

• Practice: capital-allocation inputs and constraints

  Check an indivisible budget, a displaced-sales bridge and a net-value label.

  Practice

• Discount-rate direction for positive future receipts

  Inspect a fixed nonnegative-receipt schedule before interpreting the effect of a lower rate.

  Worked examples

• Indivisible capital-budget combinations

  Evaluate feasible project sets when a ratio ranking cannot use fractions.

  Lessons

• Recovery-timing inputs and interpretation

  Read the first recorded recovery date separately from a within-period interpolation.

  Tool guides

• Discounted value and a reinvestment story

  Separate the present-value equation from an additional future-wealth assumption.

  Concepts
• 

  Capital-allocation review log

  Download a checklist record for baseline, amounts, dates, constraints and open assumptions.

  Templates

• Capital-allocation model review checklist

  Review alternatives, amount definitions, timing, constraints and numerical claims.

  Revision

• ROIC: capital base and comparison

  Match operating earnings to a stated invested-capital convention.

  Lessons

• Interchanging ROIC capital bases

  Reconcile the chosen operating denominator before substituting a funding total.

  Common mistakes

• ROIC, an average base and operating cash flow

  Reconcile the earnings numerator and capital convention before comparing a cash-flow figure.

  Worked examples

• ROIC with a defined operating-capital base

  Divide stated NOPAT by the compatible capital base and retain the period convention.

  Formulas

• Project scale, NPV and IRR rankings

  Compare two one-period schedules that rank differently by rate and amount.

  Worked examples

• Project baselines and sunk spending

  Separate already-incurred spending from cash flows changed by the next choice.

  Concepts

• Project operating and terminal cash flows

  Build the dated sequence from separately stated outlays, operations and terminal assumptions.

  Worked examples

• Project working capital and recovery

  Date the additional balance investment and justify any terminal release.

  Concepts