Module 06 · Foundations
★ Capstone

Capital Budgeting:
Choosing what's worth doing

Should you take that MBA? Refinance the mortgage? Buy the rental property? Acquire the small business? Every one of these is the same question — and the framework for answering it is the same. This module brings together everything in the track and hands you the toolkit you'll use for life.

40 minute read
7 sections
2 calculators
Excel toolkit included
6 worked decisions
6-question quiz
Section 01

The capital budgeting question

Should you take that MBA? Refinance the mortgage? Buy the rental property? Install solar panels? Acquire the small business? Take the new job that requires relocation?

Every one of these is the same kind of question — a decision involving cash flows that arrive at different times. Some flow out (initial investment, ongoing costs); some flow in (savings, revenue, returns). The fundamental question is whether the inflows, properly discounted, exceed the outflows. If they do, the decision creates wealth. If they don't, it destroys it.

This is capital budgeting. The framework is universal — the same whether the decision is at the kitchen table or in the corporate boardroom. The difference, as the Foundations track will hand off to Corporate Finance, is who's making the decision and on whose behalf.

This module is the capstone where every previous Foundations module pays off:

  • Module 01 taught you to see your cash flows clearly.
  • Module 02 showed you the instruments that move money through time.
  • Module 03 gave you the math: future value, present value, the formulas.
  • Module 04 separated real returns from nominal illusions.
  • Module 05 introduced the risk premium that determines your discount rate.

Now we use them all at once. Three core tools: Net Present Value (NPV), the gold standard; Internal Rate of Return (IRR), its companion; and Payback Period, the simple sanity check. Plus the Excel functions and toolkit that make it all work at scale.

Capital budgeting is what you do when you stop guessing whether something is "a good investment" and start computing whether it actually is. The math is the same for a $500 solar panel and a $500 million factory. Once you see it, you'll never go back to gut-feel decisions on anything that matters.
Section 02

Net Present Value — the gold standard

Net Present Value is the single most important number in finance. It directly answers the question, "How much wealth does this decision create or destroy?" The answer is in the same currency you started with.

Formula · Net Present Value
NPV = Σ [ CFt ÷ (1 + r)t ]

Sum each cash flow CFt, discounted back to today at rate r, across all periods t. Outflows are negative; inflows are positive. By convention, the initial investment occurs at t = 0 and so isn't discounted (it's already in today's money).

The decision rule

NPV > 0
Accept
Adds wealth. Take the project.
NPV = 0
Indifferent
Neither creates nor destroys value.
NPV < 0
Reject
Destroys wealth. Decline the project.

The reason NPV is the right rule, and not just one rule among many, is that it directly measures wealth creation in the units you care about. An NPV of +$25,000 means the decision is equivalent to receiving $25,000 in cash today. That number is comparable across decisions, additive across projects, and meaningful as a quantity. No other capital-budgeting metric has all three properties.

A worked example

You're considering installing a small solar array on your roof. The setup costs $10,000 today. It will save you $1,800 per year in electricity, every year for the next 8 years. After that, the panels are spent. Your discount rate (the return you could earn elsewhere on similar risk) is 5%. Is it worth it?

Year 0 1 2 3 4 5 6 7 8
Cash flow ($) −10,000 +1,800 +1,800 +1,800 +1,800 +1,800 +1,800 +1,800 +1,800
Discounted (5%) −10,000 +1,714 +1,633 +1,555 +1,481 +1,410 +1,343 +1,279 +1,218

Sum the discounted cash flows: −10,000 + 11,634 = +$1,634. NPV is positive, so install the panels. The decision is equivalent to receiving $1,634 in cash today. That's the wealth created.

Now change the discount rate to 10%. The same cash flows yield NPV = −10,000 + 9,603 = −$397. Same project, different rate, opposite decision. The discount rate matters more than almost any other input. Section 05 will return to that.

Section 03

Internal Rate of Return — the companion measure

If NPV asks, "How much wealth does this decision create at my chosen discount rate?" — IRR asks the inverse: "What discount rate would make this decision exactly break even?"

Formula · Internal Rate of Return
IRR = the rate r such that NPV(r) = 0

or most real-world cash-flow streams, there is no practical closed-form solution, so IRR is computed by iteration — a numerical search for the rate at which the discounted cash flows sum to zero. Excel's =IRR() function does this in milliseconds.

IRR is intuitive because it speaks the language of returns. "This project has an IRR of 18%" means the project effectively earns 18% per year on the money invested in it. You compare that to your required rate of return (your discount rate), and the decision rule is simple:

IRR > r
Accept
Project beats your hurdle rate.
IRR = r
Indifferent
Just clears the bar.
IRR < r
Reject
Doesn't compensate for the risk.

For our solar example with cash flows of −$10,000 followed by 8 years of +$1,800, the IRR works out to about 8.9%. That means the project breaks even at any discount rate of 8.9% — anything lower, NPV is positive; anything higher, NPV is negative. You can verify this against the worked example above: NPV was +$1,634 at 5%, and roughly −$397 at 10%, with the cross-over right around 8.9%.

When NPV and IRR conflict

For a conventional single project (accept or reject), NPV and IRR always agree. The trouble starts with mutually exclusive projects — when you can pick one or the other but not both. Here NPV and IRR can give different recommendations:

Project Initial cost NPV at 8% IRR
Project Small$10,000+$3,00025%
Project Big$100,000+$15,00014%

Project Small has the higher IRR. Project Big has the higher NPV. Which should you take, given you can only do one?

Take Project Big. The right decision rule is "maximize NPV" — that's the rule that actually maximizes your wealth. Project Big creates $15,000 of wealth versus Project Small's $3,000, even though it earns a lower percentage rate. You can't pay your rent with a percentage; you pay it with absolute dollars. IRR gets fooled by scale because it ignores the size of the investment.

⚠ Other IRR pitfalls

IRR also struggles with non-conventional cash flows that change sign more than once (a project might have multiple IRRs, or none). It implicitly assumes that interim cash flows can be reinvested at the IRR itself, which is often unrealistic. The Modified IRR (MIRR) fixes the reinvestment problem by allowing a separate reinvestment rate — useful for high-IRR projects where assuming you'll reinvest at 30% per year forever is laughable.

The lesson: report both NPV and IRR. Use NPV to decide. Use IRR to communicate. People understand "this project earns 18% per year" much faster than "this project has an NPV of $14,000 at our cost of capital" — even though only the second statement is what you actually care about.

Section 04

Payback period and the supporting cast

Three other metrics show up in capital-budgeting practice. None replaces NPV, but each adds something useful when you read it correctly.

Payback period

The number of years until cumulative cash flows turn positive — i.e., until you've recovered your initial investment. For our solar example with $10,000 down and $1,800/year coming back, the payback is $10,000 ÷ $1,800 ≈ 5.6 years.

Payback is intuitive and easy to compute, which is why it gets overused. Its weaknesses:

  • It ignores the time value of money. $1,800 today and $1,800 in year 5 count the same.
  • It ignores everything that happens after payback. A project that pays back in 3 years and then fails is treated identically to one that pays back in 3 years and then generates 30 more years of cash.
  • It can't compare projects of different scales or durations.

Use payback as a sanity check, never as a decision rule. "Payback exceeds 15 years" is a red flag worth investigating; "payback is 4 years" is reassuring but not by itself a reason to accept.

Discounted payback period

Same as payback, but using discounted cash flows. Fixes the time-value problem but not the after-payback blindness. Slightly better than naive payback. Still no substitute for NPV.

Profitability Index

The Profitability Index (PI) measures how much present value is created per dollar invested. It is defined as the present value of future cash flows divided by the initial investment:

PI = Present value of future cash flows ÷ Initial investment

A PI greater than 1.0 means the project creates wealth because the present value of inflows exceeds the upfront cost. A PI less than 1.0 means the project destroys wealth.

PI is especially useful when capital is limited and you must choose among multiple positive-NPV projects. In that setting, it helps rank projects by the amount of value created per dollar invested. However, PI can sometimes be misleading when projects differ greatly in scale or are mutually exclusive. In general, NPV remains the primary decision rule, while PI serves as a helpful supporting metric.

For most unconstrained personal decisions, NPV alone is usually enough.

Side-by-side

For our solar example at the 5% discount rate:

Metric Value Interpretation
NPV+$1,634Wealth created in today's dollars
IRR~ 8.9%The project's "earned rate"
Payback period~ 5.6 yrsTime to recover the initial outlay
Discounted payback~ 6.7 yrsSame, accounting for time value
Profitability Index1.16$1.16 of present value per $1 invested

Five different ways of saying the same thing: this project, at this discount rate, is worth doing. Different metrics, same answer.

Section 05

Choosing the discount rate

Module 05 introduced the principle: the discount rate appropriate to a project must reflect the project's risk. A guaranteed cash flow is discounted at the risk-free rate; a risky one gets a premium added on top.

For personal capital-budgeting decisions, the right discount rate is the opportunity cost of capital — the return you would earn on the next-best alternative use of the same money at similar risk. This sounds abstract; it's actually quite concrete. Three common starting points:

Decision type Rough discount rate Reasoning
Refinancing or paying down debtexisting rate on the debtSame risk profile as the debt itself
Energy / efficiency investments3–6%Cash flows are highly predictable
Education / career decisions5–8%Reasonably stable but human-capital risk
Rental real estate6–10%Depending on leverage, vacancy risk, location, and liquidity.
Small business acquisition12–20%Concentrated, illiquid, operational risk
Startup / new venture25–40%Most ventures fail; survivors must compensate

These are illustrative ranges, not precise figures. The right rate depends on your specific situation, country, and what alternatives you actually have.

The single most important practice: sensitivity analysis

Because NPV depends so heavily on the discount rate, never report a single NPV figure. Always compute it at several discount rates spanning the plausible range. If the project has positive NPV across all reasonable rates, you can decide with confidence. If the NPV is positive at 5% but negative at 10%, your conclusion depends entirely on a judgment call about the discount rate — and that needs to be made transparent.

This is why the IRR matters: it tells you the breakeven rate. If your IRR is 18% and you're confident the right discount rate is somewhere between 5% and 12%, you have a comfortable margin. If your IRR is 9% and you're choosing between 8% and 10%, you're on the edge — small judgment errors will flip the decision.

Whenever a colleague tells you "this project has a positive NPV," your next question should be "at what discount rate?" — and your second should be "and what's the IRR?" Together those two numbers contain the core financial decision.

Tool 01 · NPV / IRR Calculator

Try it

Enter the cash flows of any project: outflows negative, inflows positive. Year 0 is today. The calculator returns the NPV at your chosen discount rate, the IRR, the payback period, and the accept/reject decision.

% / yr
Your opportunity cost of capital — see Section 05 for ranges
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5

Use negative numbers for cash going out (initial investment, ongoing costs) and positive for cash coming in (savings, revenue). Year 0 is today.

NPV
$1,978
at 8%
IRR
15.24%
break-even rate
Payback
3.33 yrs
undiscounted
PI
1.20
value per $ invested
Decision
✓ ACCEPT — Creates wealth

Tool 02 · Discount-rate sensitivity

Visual

Same cash flows as Tool 01. The chart shows how NPV changes as you vary the discount rate from 0% to 30%. Where the curve crosses zero, that's the IRR — the project's break-even rate. The vertical line shows the rate you've chosen above.

NPV at each discount rate
IRR (NPV = 0)
Your chosen rate

Reading this chart: the further your IRR is from your chosen rate, the more comfortable your decision. If they're close together, small changes in your discount-rate assumption flip the conclusion — you should investigate further before committing.

Section 06

Six decisions in six cities

Capital budgeting in the wild. Each scenario is a real personal-finance decision someone might face, with the cash flows laid out, the discount rate chosen, and the NPV and IRR computed. Notice the range — some decisions clear easily, some are marginal, one fails the test entirely.

🇮🇳
Bangalore · India

The US MBA decision

A 28-year-old engineer earning ₹15 lakh considers a 2-year US MBA at ₹70 lakh tuition per year. Post-MBA salary uplift: ₹35 lakh/year for 30 years. Includes opportunity cost of foregone salary.

Y0–1: −₹85L each (tuition + foregone)
Y2–31: +₹35L/year
Discount rate: 8%
NPV +₹2.0 cr Accept
IRR ≈ 18% — far above the hurdle
🇯🇵
Tokyo · Japan

The apartment-building solar install

An owner of a small Tokyo apartment block can install ¥3M of rooftop solar that will save ¥360,000/year in electricity for 25 years. Local financing rates are around 4%.

Y0: −¥3,000,000
Y1–25: +¥360,000/year
Discount rate: 4%
NPV +¥2.6M Accept
IRR ≈ 11% — comfortably positive
🇬🇧
London · UK

The mortgage refinance

A homeowner can refinance £300k mortgage from 5% to 4%, saving £180/month for 25 remaining years. Closing costs: £6,000 paid upfront.

Y0: −£6,000 (closing costs)
Y1–25: +£2,160/year (savings)
Discount rate: 4%
NPV +£27,700 Accept
IRR ≈ 36% — payback under 3 years
🇧🇷
São Paulo · Brazil

The coffee roaster acquisition

Acquire an established coffee roaster business for R$500,000. Generates R$120,000/year for 8 years; sell the business for R$300,000 at the end. Brazilian small-business hurdle: 12%.

Y0: −R$500,000
Y1–7: +R$120,000/year
Y8: +R$420,000 (operating + sale)
Discount rate: 12%
NPV +R$217k Accept
IRR ≈ 22% — strong margin over hurdle
🇩🇪
Berlin · Germany

The rental studio

Buy a small studio apartment for €200,000 cash. Net rental income (after tax and maintenance): €10,000/year for 25 years. Expected sale value at the end: €300,000.

Y0: −€200,000
Y1–24: +€10,000/year
Y25: +€310,000 (rent + sale)
Discount rate: 5%
NPV +€29.5k Accept
IRR ≈ 5.9% — barely beats the hurdle
🇳🇬
Lagos · Nigeria

The borehole well

A small farm can drill a ₦5M borehole well to replace expensive water purchases. Annual savings: ₦800,000 for 15 years. Nigerian government bond yields run high — appropriate hurdle: 15%.

Y0: −₦5,000,000
Y1–15: +₦800,000/year
Discount rate: 15%
NPV −₦322k Reject
IRR ≈ 13.7% — below the hurdle rate

Five accepts and one reject. Notice the Lagos case carefully: a project that "looks profitable" by simple logic — saving ₦12M total over 15 years on a ₦5M investment — actually destroys wealth at the appropriate Nigerian discount rate. The high required return reflects high inflation and high alternative yields. The same project at 5% would be wildly attractive; at 15%, it doesn't clear the bar.

This is exactly why discount-rate selection is the most consequential decision in capital budgeting, and why sensitivity analysis is non-negotiable. Two analysts looking at the same cash flows, choosing different discount rates, can reach opposite conclusions — and both can be right, given their assumptions.

The Excel toolkit

Every calculation above can be done in Excel using a small set of built-in functions. The two essentials are NPV() and IRR().

// NPV at 8% discount rate, where year 0 is in cell B2 and years 1-5 are in B3:B7   = B2 + NPV(0.08, B3:B7) $1,978   // IRR using the full range B2:B7 (includes year 0)   = IRR(B2:B7) 15.24%

The NPV() function quirk

Excel's NPV() function discounts the first value by one period — it assumes the first cash flow is at the end of year 1, not at year 0. If your initial investment is at year 0 (which it usually is), you need to add it separately, outside the function. Hence the pattern = initial + NPV(rate, year1_through_N). This is the single most common mistake in spreadsheet capital budgeting; getting it wrong systematically over- or under-discounts everything.

For decisions with irregular dates — cash flows that don't fall neatly on annual periods — use XNPV() and XIRR() instead. They take a list of cash flows and a list of dates and handle the time arithmetic automatically.

  Companion Workbook

The Globefin Capital Budgeting Toolkit

A six-sheet Excel workbook for evaluating any project. Enter cash flows for up to 15 years and watch the NPV, IRR, payback, and PI update live. Includes a sensitivity table, a project-comparison sheet, and the six worked examples above with auto-checked answers.

  • NPV / IRR Calculator (15-year horizon)
  • Discount-rate sensitivity table
  • Side-by-side project comparison
  • Six practice cases with instant ✓ / ✗ feedback
  • Excel function reference card
  • Sign convention & quirk reminder
Download .xlsx
Self-examination · Capstone

Six questions before Foundations is yours.

The final examination of the track. The questions test whether you can apply the capital-budgeting framework to real decisions, recognize the limits of each metric, and choose discount rates honestly.

Module 06 · Capstone Examination

Q1 of 6
★ Foundations of Finance · Track Complete ★

You've finished the Foundations.

Across six modules you've built a working financial intuition that operates in any currency, on any continent. You can read your own cash flows, move them through time at the right rate, separate real returns from nominal illusions, price the risk in any expected return, and use NPV to decide whether any decision involving future cash flows is actually worth making.

That's the universal toolkit of personal finance. Everything that comes next — corporate finance, investments, international finance — is a specialization or extension of what you now know.

Module 01
Budgeting & Cash Flow
Module 02
Saving & Borrowing
Module 03
Time Value Calculations
Module 04
Inflation & Real Returns
Module 05
Risk & Return
Module 06 · Capstone
Capital Budgeting
Next track · Coming soon

Corporate Finance

Now that you understand finance from the perspective of someone who is both decision-maker and beneficiary, the next track flips the frame. Corporate finance is what happens when those two roles separate — when one person makes financial decisions on behalf of others. Capital structure, cost of capital, capital budgeting at the firm, dividend policy, M&A — all viewed through the lens of the agency problem.

Back to all tracks