This final lesson covers the practical considerations in capital budgeting, including capital rationing, the profitability index as a selection tool, and the importance of post-audits. These topics are covered in corporate finance curricula that emphasise practical application.

• Capital Rationing: Capital rationing occurs when a firm has more acceptable investment opportunities than it has funds to finance them. This may be due to:

  • Soft Capital Rationing: Internal constraints imposed by management (e.g., limiting investment budget to control spending)

  • Hard Capital Rationing: External constraints where the firm cannot raise additional capital in the financial markets

  • The HSE syllabus identifies capital rationing as a topic in capital budgeting analysis

• Selecting Projects under Capital Rationing: When funds are limited, firms must select the combination of projects that maximises total NPV within the available budget. This often involves evaluating projects and ranking them by profitability index (NPV per dollar invested). The Coursera Advanced Corporate Finance Strategies course includes a module on “Capital Rationing and Project Risk Analysis”.

• Profitability Index (PI): The profitability index is a relative measure of present value that is useful when capital is constrained. It is calculated as:

  • PI = Present Value of Future Cash Flows / Initial Investment

  • A PI greater than 1 indicates the project creates value

  • The PI is particularly useful when comparing projects of different sizes under capital rationing

• Post-Audits: A post-audit is a review of an investment project’s actual performance compared to its projected performance. The post-audit provides valuable feedback by:

  • Identifying areas where estimates were inaccurate

  • Improving future forecasting accuracy

  • Holding managers accountable for investment decisions

  • Identifying projects that may need corrective action

• Projects with Unequal Lives: When comparing mutually exclusive projects with different economic lives, special techniques are needed to ensure fair comparison. The Advanced Corporate Finance Strategies course covers “Projects with Unequal Lives” as part of its capital budgeting curriculum.

• The Cost of Capital and Capital Budgeting Connection: The capital budgeting decision and the capital structure decision cannot be treated separately when corporate taxes are considered. The Weighted Average Cost of Capital (WACC) serves as the discount rate for evaluating projects. The HSE syllabus also covers “Adjusted present value (APV), weighted average cost of capital (WACC) approach and free cash flow to equity (FCFE)” as advanced approaches to accounting for project financing side effects