Capital Budgeting (Investment Decisions)

Core concepts

1. 01Long-term investment decisions involving capital expenditure.
2. 02Techniques: Payback, ARR (traditional); NPV, IRR, PI, Discounted Payback (DCF).
3. 03NPV decision rule: accept if NPV > 0; for mutually exclusive — choose highest NPV.
4. 04IRR: discount rate at which NPV = 0; may have multiple IRRs with non-conventional cash flows.
5. 05Risk analysis: sensitivity, scenario, Monte Carlo, certainty equivalent, risk-adjusted discount rate.

Exam-critical pointers

• ⭐NPV preferred over IRR for mutually exclusive projects (scale/timing differences).
• ⭐PI useful when capital is rationed.
• ⭐Inflation: nominal cash flows discounted at nominal rate; real CF at real rate.
• ⭐Replacement decisions: incremental cash flows + opportunity cost of existing asset.