Tiêu đề LM05 Capital Investments and Capital Allocation IFT Notes.pdf ✅

LM05 Capital Investments and Capital Allocation 2025 Level I Notes © IFT. All rights reserved 1 LM05 Capital Investments and Capital Allocation 1. Introduction ........................................................................................................................................................... 2 2. Capital Investments ............................................................................................................................................ 2 3. Capital Allocation ................................................................................................................................................. 4 4. Capital Allocation Principles and Pitfalls................................................................................................. 10 5. Real Options ........................................................................................................................................................12 Summary ...................................................................................................................................................................14 Required disclaimer: IFT is a CFA Institute Prep Provider. Only CFA Institute Prep Providers are permitted to make use of CFA Institute copyrighted materials which are the building blocks of the exam. We are also required to create / use updated materials every year and this is validated by CFA Institute. Our products and services substantially cover the relevant curriculum and exam and this is validated by CFA Institute. In our advertising, any statement about the numbers of questions in our products and services relates to unique, original, proprietary questions. CFA Institute Prep Providers are forbidden from including CFA Institute official mock exam questions or any questions other than the end of reading questions within their products and services. CFA Institute does not endorse, promote, review or warrant the accuracy or quality of the product and services offered by IFT. CFA Institute®, CFA® and “Chartered Financial Analyst®” are trademarks owned by CFA Institute. © Copyright CFA Institute Version 1.0
LM05 Capital Investments and Capital Allocation 2025 Level I Notes © IFT. All rights reserved 2 1. Introduction Capital investments are investments with a life of one year or more. Companies make capital investments to generate value for their shareholders. Capital allocation is the process by which companies make capital investment decisions. Capital allocation is important because it impacts a company’s future. This learning module covers:  Types of capital investments – going concern, regulatory/compliance, expansion, and other projects  Steps in a typical capital allocation process  Basic investment decision criteria – NPV, IRR, and ROIC  Principles of capital allocation and common capital allocation pitfalls  Types of real options – timing, sizing, flexibility, and fundamental options 2. Capital Investments Capital investments are shown on the balance sheet as long-term assets. A portion of the cost is recorded on the income statement periodically as a non-cash depreciation or amortization expense over the asset’s useful life. In subsequent periods, the amount on the balance sheet is shown on a net basis, i.e., initial cost – accumulated depreciation. The net value declines to zero or a salvage value at the end of the asset’s useful life. Exhibit 1 from the curriculum illustrates this process.
LM05 Capital Investments and Capital Allocation 2025 Level I Notes © IFT. All rights reserved 3 Types of Capital Projects Companies invest for two primary reasons – to maintain their existing business and to grow it. Projects undertaken by companies to maintain the business include:  Going concern projects: Projects necessary to continue current operations and maintain existing size of the business or to improve business efficiencies. Example: machine replacement, infrastructure improvement  Regulatory/Compliance projects: Projects typically required by a third party, such as the government regulatory body, to meet specified safety and compliance standards. Example: factory pollution control installation, performance bond posting to guarantee satisfactory project completion Projects undertaken by companies to expand the business include:  Expansion projects: Projects that expand business size and typically involve greater degrees of risk and uncertainty than going concern projects. Example: new product or service development, merger, acquisition  Other projects: Projects, which include high-risk investments and new growth initiatives, that are outside the company’s conventional business lines. Example: exploration investment into a new innovation, business model, or idea Going Concern Projects  Projects necessary to continue current operations and maintain existing size of the business or to improve business efficiencies.  Most common going concern projects are replacing assets that have reached the end of their useful life, and maintaining IT hardware and software.  Typically, these projects do not increase revenues but they could help a company save costs.  They are fairly easy to evaluate as compared to the other projects.  To fund these projects, managers often try to match the financing with the life-span of the asset. For example, issuing a 20-year bond to fund an asset with an expected life of 20-years. o If a company finances long-term assets with short-term financing, it faces rollover risk – the short-term financing costs could go up. o If a company finances short-term assets with long-term financing, it faces the risk of overpaying in financing costs.  To estimate the amount of capital spending on going concern projects, analysts often look at the depreciation and amortization expense reported on the income statement.