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CPA PEP Finance Elective study materials
CPA PEP Finance Elective study resources

CPA PEP Finance Elective: Corporate Finance and Capital Investment Decisions

CPA PEP Finance Elective · Work through your exam, one topic at a time.

All guide sections

Corporate Finance and Capital Investment Decisions

Corporate Finance and Capital Investment Decisions tests incremental cash-flow thinking: what changes if the project is accepted, which discount rate applies, and which of several mutually exclusive alternatives adds the most value.

Core rules

  • NPV is the primary decision rule; IRR, payback, discounted payback, and profitability index are screening tools. PI = PV of inflows / initial outlay and is useful only when capital is rationed.
  • Include only incremental after-tax cash flows. Exclude sunk costs; include opportunity costs (foregone rent, cannibalized margin) and working capital, and recover working capital at project end.
  • Under Canadian tax rules the shield comes from CCA, not accounting depreciation. Class 8 is 20% declining balance with the half-year rule on additions; the present value of the tax shield is C × d × T / (d + k) adjusted for the half-year rule, reduced by the lost shield on salvage.
  • Discount at a rate matched to the project's risk, not automatically at the corporate WACC.
  • Mutually exclusive projects with different lives: compare equivalent annual annuities or force a common horizon.
  • Real options - defer, expand, abandon - carry value that static NPV ignores; flag them qualitatively when data is missing.

Worked example

A $300,000 machine saves $150,000 per year pre-tax for three years, is written off straight-line for tax, tax is 25%, and the required return is 12%. Annual after-tax operating cash flow = 150,000 × (1 − 0.25) + 100,000 × 0.25 = 112,500 + 25,000 = $137,500. The three-year annuity factor at 12% is 2.4018, so PV = $330,252 and NPV = $30,252 - accept. The $25,000 depreciation shield is a benefit only because it reduces tax; depreciation itself is never a cash outflow.

Traps that cost marks

  • Deducting a sunk feasibility study or allocated head-office overhead.
  • Omitting working capital investment or forgetting its recovery.
  • Ranking by IRR when projects differ in scale or in the timing of cash flows.
  • Applying the half-year rule in the wrong year, or ignoring how salvage lowers closing UCC.
  • Discounting nominal cash flows at a real rate, or nominal at real.