capital investment case study

How capital expenditure management can drive performance

One of the quickest and most effective ways for organizations to preserve cash is to reexamine their capital investments. The past two years have offered a fascinating look into how different sectors have weathered the COVID-19 storm: from the necessarily capital expenditure–starved airport industry to the cresting wave of public-sector investments in renewable infrastructure and anticipation of the next mining supercycle. Indeed, companies that reduce spending on capital projects can both quickly release significant cash and increase ROIC, the most important metric of financial value creation (Exhibit 1).

This strategy is even more vital in competitive markets, where ROIC is perilously close to cost of capital. In our experience, organizations that focus on actions across the whole project life cycle, the capital project portfolio, and the necessary foundational enablers can reduce project costs and timelines by up to 30 percent to increase ROIC by 2 to 4 percent. Yet managing capital projects is complex, and many organizations struggle to extract cost savings. In addition, ill-considered cuts to key projects in a portfolio may actually jeopardize future operating performance and outcomes. This dynamic reinforces the age-old challenge for executives as they carefully allocate marginal dollars toward value creation.

Companies can improve their odds of success by focusing on areas of the project life cycle— capital strategy and portfolio optimization , project development and value improvement, and project delivery and construction—while investing in foundational enablers.

Cracking the code on capital expenditure management

Despite the importance of capital expenditure management in executing business strategy, preserving cash, and maximizing ROIC, most companies struggle in this area for two primary reasons. First, capital expenditure is often not a core business; instead, organizations focus on operating performance, where they have extensive institutional knowledge. When it comes to capital projects, executives rely on a select few people with experience in capital delivery. Second, capital performance is typically a black box. Executives find it difficult to understand and predict the performance of individual projects and the capital project portfolio as a whole.

Across industries, we see companies struggle to deliver projects on time and on schedule (Exhibit 2). In fact, cost and schedule overruns compared with original estimates frequently exceed 50 percent. Notably, these occur in both the public and private sectors.

The COVID-19 pandemic has accelerated and magnified these challenges. Governments are increasingly viewing infrastructure spending as a tool for economic stimulus, which amplifies the cyclical nature of capital expenditure deployments. At the same time, some organizations have had to make drastic cutbacks in capital projects because of difficult economic conditions. The reliance on just a few experienced people when travel restrictions necessitated a remote-operating model further increased the complexity. As a result, only a few organizations have been able to maintain a through-cycle perspective.

In addition, current inflation could put an end to the historically low interest rates that companies are enjoying for financing their projects. As the cost of capital goes up, discipline in managing large projects will become increasingly important.

Improving capital expenditure management

In our experience, the organizational drivers that impede capital expenditure management affect all stages of a project life cycle, from portfolio management to project execution and commissioning. Best-in-class capital development and delivery require companies to outperform in three main areas, supported by several foundational enablers (Exhibit 3).

Recipes for capturing value

Companies can transform the life cycle of a capital expenditure project by focusing on three areas: capital strategy and portfolio optimization, project development and value improvement, and project delivery and construction. While the savings potential applies to each area on a stand-alone basis, their impact has some overlap. In our experience, companies that deploy these best practices are able to save 15 to 30 percent of a project’s cost.

Capital strategy and portfolio optimization

The greatest opportunity to influence a project’s outcome comes at its start. Too often, organizations commit to projects without a proper understanding of business needs, incurring significant expense to deliver an outcome misaligned with the overall strategy. Indeed, a failure to adequately recognize, price, and manage the inherent risks of project delivery is a recurring issue in the industry. Organizations can address this challenge by following a systematic three-step approach:

Assess the current state of capital projects and portfolio. It’s essential to identify strengths, areas of improvement, and the value at stake. To do so, organizations must build a transparent and rigorously tested baseline and capital budget, which should provide a clear understanding of the overall capital expenditure budget for the coming years as well as accurate cost and time forecasts for an organization’s portfolio of capital projects.

Ensure capital allocation is linked to overall company strategy. This step involves reviewing sources and uses of cash and ensuring allocated capital is linked to strategy. Companies must set an enterprise-wide strategy , assess the current portfolio against the relevant market with forward-looking assessments and cash flow simulation, and review sources and uses of cash to determine the amount of capital available. Particular focus should be given to environmental, social, and governance (ESG) considerations—by both proactively managing risks and capturing the full upside opportunity of new projects—because sustainability is becoming a real source of shareholder value (Exhibit 4). With this knowledge, organizations can identify internal and external opportunities to strengthen their portfolio based on affordability and strategic objectives.

Optimize the capital portfolio to increase company-wide ROIC. Executives should distinguish between projects that are existing or committed, planned and necessary (for legal, regulatory, or strategic requirements), and discretionary. They can do so by challenging a project’s justification, classifications, benefit estimates, and assumptions to ensure they are realistic. This analysis helps companies to define and calibrate their portfolios by prioritizing projects based on KPIs and discussing critical projects not in the portfolio. Executives can then verify that the portfolio is aligned with the business strategy, risk profile, and funding constraints.

For example, a commercial vehicle manufacturer recently undertook a rigorous review of its project portfolio. After establishing a detailed baseline covering several hundred planned projects in one data set, the manufacturer classified the projects into two categories: must-have and discretionary. It also considered strategic realignment in light of a shift to e-mobility and the implications on investments in internal-combustion-engine vehicles. Last, it scrutinized individual maintenance projects to reduce their scope. Overall, the manufacturer uncovered opportunities to decrease its capital expenditure budget by as much as 20 percent. This strict review process became part of its annual routine.

Project development and value improvement

While value-engineering exercises are common, we find that 5 to 15 percent of additional value is typically left on the table. Too often, organizations focus on technical systems and incremental improvements. Instead, executives should consider the full life cycle cost across several areas:

Sourcing the right projects with the right partners. Companies must ensure they are sourcing the right projects by aligning on prioritization criteria and identifying the sectors to play in based on their strategy. Once these selections are made, organizations can use benchmarking and advanced-analytics tools to accelerate project timelines and improve planning. Building the right consortium of contractors and partners at the outset and establishing governance and reporting can have a huge impact. Best-in-class teams secure the optimal financing, which can include public and private sources, by assessing the economic, legal, and operational implications for each option.

A critical success factor is a strong tendering office, which focuses on choosing better projects. It can increase the likelihood of winning through better partnerships and customer insights and enhance the profitability of bids with creative solutions for reducing cost and risk. Best-in-class tendering offices identify projects aligned with the company’s strategy, have a clear understanding of success factors, develop effective partnerships across the value chain, and implement a risk-adjusted approach to pricing.

Achieve the full potential of the preconstruction project value. Companies can take a range of actions to strengthen capital effectiveness. For example, they should consider the project holistically, including technical systems, management systems, and mindsets and behaviors. To ensure they create value across all stages of the project life cycle, organizations should design contract and procurement interventions early in the project. An emphasis on existing ideas and proven solutions can help companies avoid getting bogged down in developing new solutions. For instance, a minimum-technical-solution approach can be used to identify the highest-value projects by challenging technical requirements once macro-elements are confirmed.

Companies should also seek to formalize dedicated systems and processes to support decision making and combat bias. We have identified five types of biases to which organizations should pay close attention (Exhibit 5). For instance, interest biases should be addressed by increasing transparency in decision making and aligning on explicit decision criteria before assessing the project. Stability biases can also be harmful. We have seen it too many times: companies have a number of underperforming projects that just won’t die and that take up valuable and already limited available resources. Organizations should invest in quickly determining when to halt projects—and actually stop them.

Setting up a system to take action in a nonbiased way is a crucial element of best-in-class portfolio optimization. Changing the burden of proof can also help. One energy company counterbalanced the natural desire of executives to hang on to underperforming assets with a systematic process for continually upgrading the company’s portfolio. Every year, the CEO asked the corporate-planning team to identify 3 to 5 percent of the company’s assets that could be divested. The divisions could retain any assets placed in this group but only if they could demonstrate a compelling turnaround program for them. The burden of proof was on the business units to prove that an asset should be retained, rather than just assuming it should.

An effective governance system ensures that all ideas generated from project value improvements are subject to robust tracking and follow-up. Further, the adoption of innovative digital and technological solutions can enhance standardization, modularization, transparency, and efficiency. A power company recently explored options to phase out coal-powered energy using a project value improvement methodology and a minimum technical solution. The process helped to articulate options to maximize ROI and minimize greenhouse-gas emissions. An analysis of each option, using an idea bank of more than 2,000 detailed ideas, let the company find solutions to reduce investment on features with little value added, reallocate spending to more efficient technologies, and better adjust capacity configurations with business needs. Ultimately, the company reduced capital costs by 30 percent while increasing CO 2 abatement by the same amount.

Designing the right project organization. An open, collaborative, and result-focused environment enabled by stringent performance management processes is critical for success, regardless of the contractual arrangement between owners and contractors. Improving capital project practices is possible only if companies measure those practices and understand where they stand compared with their peers. The organization should be designed with a five-year capital portfolio in mind and built by developing structures for project archetypes and modeling the resources required to deliver the capital plan. A rigorous stage-gate process of formal reviews should also be implemented to verify the quality of projects moving forward. Too many projects are rushed through phases with no formal review of their deliverables, leading to a highly risky execution phase, which usually results in delays and cost overruns.

As successful organizations demonstrate, addressing organizational health in project teams is as important as performance initiatives. McKinsey research has found that the healthiest organizations generate three times higher returns than companies in the bottom quartile and more than 60 percent higher returns compared with companies in the middle two quartiles. 1 Scott Keller and Bill Schaninger, Beyond Performance 2.0: A Proven Approach to Leading Large-Scale Change , second edition, Hoboken, NJ: Wiley, 2019.

Project delivery and construction

Since the root causes of poor performance—project complexity, data quality, execution capabilities, and incentives and mindsets—can be difficult to identify and act on, organizations can benefit from taking the following actions across project delivery and construction dimensions.

Optimize the project execution plan. Organizations should embrace principles of operations science to develop an optimized configuration for the production system, as well as set a competitive and realistic baseline for the project. This execution plan identifies the execution options that could be deployed on the project and key decisions that need to be made. Companies should also break the execution plan into its microproduction systems and visualize the complicated schedule. Approaching capital projects as systems allows companies to apply operations science across process design, capacity, inventory, and variability.

Contract, claims, and change orders management. While claims are quite common on capital projects, proactive management can keep them under control and allow owners to retain significant value. Focusing on claims avoidance when drafting terms and conditions can head off many claims before they arise. In addition, partnering with contractors creates a more collaborative environment, making them less inclined to pursue an aggressive claims strategy. To manage change orders on a project, companies should address their contract management capability, project execution change management, and project closeout negotiation support. A European chemical company planning to build greenfield infrastructure in a new Asian geography recently employed this approach. It reduced risk on the project by bringing together bottom-up, integrated planning and performance management with targeted lean-construction interventions. By doing so, the company reduced the project’s duration by a year, achieved on-time delivery, and stayed within its €1 billion budget.

Enablers of the capital transformation

These three value capture areas must be supported by a capable organization with the right tools and processes—what we call the “transformational chassis.” To establish this infrastructure, organizations should focus on several activities.

Performance management

The best organizations institute a performance management system to implement a cascading set of project review meetings focused on assessing the progress of value-creation initiatives. Building on a foundation of quality data, the right performance conversations must take place at all levels of the organization.

Companies should also be prepared to reexamine their stage-gate governance system to shift from an assurance mindset (often drowning in bureaucracy and needless reporting) to an investor mindset. Critical value-enabling activities should be defined at each stage of the project life cycle, supported by a playbook of best practices for execution and implemented by a project review board. While governance processes exist, they often involve reporting without decision making or are not focused on the right outcomes—for example, ensuring that the investment decision and thesis remain valid through a project’s life. Quite often, companies provide incentives for project managers to execute an outdated project plan rather than deliver against the organization’s needs and goals.

Creating project transparency is also critical. Companies should establish a digital nerve center—or control tower—that collects field-level data to establish a single source of truth and implement predictive analytics. Equally important, companies must address capability building to ensure that the team has a solid understanding of the baseline and embraces data-based decision making.

Companies should stand up delivery teams that integrate owner and contractor groups across disciplines and institute a consistent and effective project management rhythm that can identify risks and opportunities over a project’s duration. Once delivery teams prioritize the biggest opportunities, dedicated capacity should be allocated to solve a project’s most challenging problems. Finally, companies should build and deploy comprehensive programs that improve culture and workforce capabilities throughout the organization, including the front line.

Capital analytics

Many organizations struggle to get a clear view of how projects are performing, which limits the possibility for timely interventions, decision making, and resource planning. By digitalizing the performance management of construction projects using timely and transparent project data, companies can track value capture and leading indicators while making data available across the enterprise. Using a single source of truth can reduce delivery risk, increase responsiveness, and enable a more proactive approach to the identification of issues and the capture of opportunities. The most advanced projects build automated, real-time control towers that consolidate information across systems, engineering disciplines, project sites, contractors, and broader stakeholders. The ability to integrate data sets speeds decision making, unlocks further insights, and promotes collaborative problem solving between the company that owns the capital project and the engineering, procurement, and construction company.

Ways of working

In many cases, executives are unwilling to engage in comprehensive capital reviews because they lack a sufficient understanding of capital management processes, and project managers can be afraid to expose this lack of proficiency. Agile practices can facilitate rapid and effective decision making by bringing together cross-functional project teams. Under this approach, organizations establish daily stand-ups, weekly showcases, and fortnightly sprints to help eliminate silos and maintain a focus on top priorities. Agility must be supported by an organizational structure, well-developed team capabilities, and an investment mindset. Organizations should also build skills and establish a culture of cooperation to optimize their capital investments.

We do recognize that getting capital expenditure management right feels like a lot to do well. And although many of these tasks are somehow done by a slew of companies, pockets of organizational excellence can be undermined instantly (and sometimes existentially) by one big project that goes wrong or a strategic misfire that pushes an organization from being a leader to a laggard in the investment cycle. In some ways, capital expenditure management leaders face similar challenges to those in other functions that have already undergone major productivity improvements: often these challenges are not technical problems but instead relate to how people work together toward a common goal.

Yet we believe organizations have a significant opportunity to fundamentally improve project outcomes by rethinking traditional approaches to project delivery. Sustainable improvements can be achieved by resizing the project portfolio, optimizing the cash flows for individual projects, and improving and reducing individual project delivery risk.

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11.1 Describe Capital Investment Decisions and How They Are Applied

Assume that you own a small printing store that provides custom printing applications for general business use. Your printers are used daily, which is good for business but results in heavy wear on each printer. After some time, and after a few too many repairs, you consider whether it is best to continue to use the printers you have or to invest some of your money in a new set of printers. A capital investment decision like this one is not an easy one to make, but it is a common occurrence faced by companies every day. Companies will use a step-by-step process to determine their capital needs, assess their ability to invest in a capital project, and decide which capital expenditures are the best use of their resources.

Fundamentals of Capital Investment Decisions

Capital investment (sometimes also referred to as capital budgeting ) is a company’s contribution of funds toward the acquisition of long-lived (long-term or capital) assets for further growth. Long-term assets can include investments such as the purchase of new equipment, the replacement of old machinery, the expansion of operations into new facilities, or even the expansion into new products or markets. These capital expenditures are different from operating expenses. An operating expense is a regularly-occurring expense used to maintain the current operations of the company, but a capital expenditure is one used to grow the business and produce a future economic benefit.

Capital investment decisions occur on a frequent basis, and it is important for a company to determine its project needs to establish a path for business development. This decision is not as obvious or as simple as it may seem. There is a lot at stake with a large outlay of capital, and the long-term financial impact may be unknown due to the capital outlay decreasing or increasing over time. To help reduce the risk involved in capital investment, a process is required to thoughtfully select the best opportunity for the company.

The process for capital decision-making involves several steps:

• Determine capital needs for both new and existing projects.
• Identify and establish resource limitations.
• Establish baseline criteria for alternatives.
• Evaluate alternatives using screening and preference decisions.
• Make the decision.

The company must first determine its needs by deciding what capital improvements require immediate attention. For example, the company may determine that certain machinery requires replacement before any new buildings are acquired for expansion. Or, the company may determine that the new machinery and building expansion both require immediate attention. This latter situation would require a company to consider how to choose which investment to pursue first, or whether to pursue both capital investments concurrently.

Concepts In Practice

The decision to invest money in capital expenditures may not only be impacted by internal company objectives, but also by external factors. In 2016, Great Britain voted to leave the European Union (EU) (termed “Brexit”), which separates their trade interests and single-market economy from other participating European nations. This has led to uncertainty for United Kingdom (UK) businesses.

Because of this instability, capital spending slowed or remained stagnant immediately following the Brexit vote and has not yet recovered growth momentum. 1 The largest decrease in capital spending has occurred in the expansions of businesses into new markets. The UK is expected to separate from the EU in 2019.

The second step, exploring resource limitations, evaluates the company’s ability to invest in capital expenditures given the availability of funds and time. Sometimes a company may have enough resources to cover capital investments in many projects. Many times, however, they only have enough resources to invest in a limited number of opportunities. If this is the situation, the company must evaluate both the time and money needed to acquire each asset. Time allocation considerations can include employee commitments and project set-up requirements. Fund limitations may result from a lack of capital fundraising, tied-up capital in non-liquid assets, or extensive up-front acquisition costs that extend beyond investment means ( Table 11.1 ). Once the ability to invest has been established, the company needs to establish baseline criteria for alternatives.

Alternatives are the options available for investment. For example, if a company needs to purchase new printing equipment, all possible printing equipment options are considered alternatives. Since there are so many alternative possibilities, a company will need to establish baseline criteria for the investment. Baseline criteria are measurement methods that can help differentiate among alternatives. Common measurement methods include the payback method, accounting rate of return, net present value, or internal rate of return. These methods have varying degrees of complexity and will be discussed in greater detail in Evaluate the Payback and Accounting Rate of Return in Capital Investment Decisions and Explain the Time Value of Money and Calculate Present and Future Values of Lump Sums and Annuities

To evaluate alternatives, businesses will use the measurement methods to compare outcomes. The outcomes will not only be compared against other alternatives, but also against a predetermined rate of return on the investment (or minimum expectation) established for each project consideration. The rate of return concept is discussed in more detail in Balanced Scorecard and Other Performance Measures . A company may use experience or industry standards to predetermine factors used to evaluate alternatives. Alternatives will first be evaluated against the predetermined criteria for that investment opportunity, in a screening decision. The screening decision allows companies to remove alternatives that would be less desirable to pursue given their inability to meet basic standards. For example, if there were three different printing equipment options and a minimum return had been established, any printers that did not meet that minimum return requirement would be removed from consideration.

If one or more of the alternatives meets or exceeds the minimum expectations, a preference decision is considered. A preference decision compares potential projects that meet screening decision criteria and will rank the alternatives in order of importance, feasibility, or desirability to differentiate among alternatives. Once the company determines the rank order, it is able to make a decision on the best avenue to pursue ( Figure 11.2 ). When making the final decision, all financial and non-financial factors are deliberated.

Ethical Considerations

Volkswagen diesel emissions scandal.

Sometimes a company makes capital decisions due to outside pressures or unforeseen circumstances. The New York Times reported in 2015 that the car company Volkswagen was “scarred by an emissions-cheating scandal,” and “would need to cut its budget next year for new technology and research—a reversal after years of increased spending aimed at becoming the world’s biggest carmaker.” 2 This was a huge setback for Volkswagen , not only because the company had budgeted and planned to become the largest car company in the world, but also because the scandal damaged its reputation and set it back financially.

Volkswagen “set aside about 9 billion euros ($9.6 billion) to cover costs related to making the cars compliant with pollution regulations;” however, the sums were “unlikely to cover the costs of potential legal judgments or other fines.” 3 All of the costs related to the company’s unethical actions needed to be included in the capital budget, as company resources were limited. Volkswagen used capital budgeting procedures to allocate funds for buying back the improperly manufactured cars and paying any legal claims or penalties. Other companies might take other approaches, but an unethical action that results in lawsuits and fines often requires an adjustment to the capital decision-making process.

Let’s broadly consider what the five-step process for capital decision-making looks like for Melanie’s Sewing Studio. Melanie owns a sewing studio that produces fabric patterns for wholesale.

• Determine capital needs for both new and existing projects. Upon review of her future needs, Melanie determines that her five-year-old commercial sewing machine could be replaced. The old machine is still working, but production has slowed in recent months with an increase in repair needs and replacement parts. Melanie expects a new sewing machine to make her production process more efficient, which could also increase her current business volume. She decides to explore the possibility of purchasing a new sewing machine.
• Identify and establish resource limitations. Melanie must consider if she has enough time and money to invest in a new sewing machine. The Sewing Studio has been in business for three years and has shown steady financial growth year over year. Melanie expects to make enough profit to afford a capital investment of $50,000. If she does purchase a new sewing machine, she will have to train her staff on how to use the machine and will have to cease production while the new machine is installed. She anticipates a loss of $20,000 for training and production time. The estimation of the $20,000 loss is based on the downtime in production for both labor and product output.
• Establish baseline criteria for alternatives. Melanie is considering two different sewing machines for purchase. Before she evaluates which option is a better investment, she must establish minimum requirements for the investment. She determines that the new machine must return her initial investment back to her in three years at a rate of 20%, and the initial investment cost cannot exceed her future earnings. This established a baseline for what she considers reasonable for this type of investment, and she will not consider any investment alternative that does not meet these minimum criteria.
• Evaluate alternatives using screening and preference decisions. Now that she has established minimum requirements for the new machine, she can evaluate each of these machines to see if they meet or exceed her criteria. The first sewing machine costs $45,000. She is expected to recoup her initial investment in two-and-a-half years. The return rate is 25%, and her future earnings would exceed the initial cost of the machine. The second machine will cost $55,000. She expects to recoup her initial investment in three years. The return rate is $18%, and her future earnings would be less than the initial cost of the machine.
• Make the decision. Melanie will now decide which sewing machine to invest in. The first machine meets or exceeds her established minimum requirements in cost, payback, return rate, and future earnings compared to the initial investment. For the second machine, the $55,000 cost exceeds the cash available for investment. In addition, the second machine does not meet the return rate of 20% and the anticipated future earnings does not compare well to the value of the initial investment. Based on this information, Melanie would choose to purchase the first sewing machine. These steps make it seem as if narrowing down the alternatives and making a selection is a simple process. However, a company needs to use analysis techniques, including the payback method and the accounting rate of return method, as well as other, more sophisticated and complex techniques, to help them make screening and preference decisions. These techniques can assist management in making a final investment decision that is best for the company. We begin learning about these various screening and preference decisions in Evaluate the Payback and Accounting Rate of Return in Capital

Link to Learning

More and more companies are using capital expenditure software in budgeting analysis management. One company using this software is Solarcentury, a United Kingdom-based solar company. Read this case study on Solarcentury’s advantages to capital budgeting resulting from this software investment to learn more.

• 1 G. Jackson “UK Business Investment Stalls in Year since Brexit Vote.” The Financial Times . August 24, 2017. https://www.ft.com/content/daff3ffe-88ac-11e7-8bb1-5ba57d47eff7
• 2 Jack Ewing and Jad Mouawad. “VW Cuts Its R&D Budget in Face of Costly Emissions Scandal.” New York Times . November 20, 2015. https://www.nytimes.com/2015/11/21/business/international/volkswagen-emissions-scandal.html
• 3 Jack Ewing and Jad Mouawad. “VW Cuts Its R&D Budget in Face of Costly Emissions Scandal.” New York Times . November 20, 2015. https://www.nytimes.com/2015/11/21/business/international/volkswagen-emissions-scandal.html

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How Venture Capitalists Make Decisions

• Paul Gompers,
• Will Gornall,
• Steven N. Kaplan,
• Ilya A. Strebulaev

For decades now, venture capitalists have played a crucial role in the economy by financing high-growth start-ups. While the companies they’ve backed—Amazon, Apple, Facebook, Google, and more—are constantly in the headlines, very little is known about what VCs actually do and how they create value. To pull the curtain back, Paul Gompers of Harvard Business School, Will Gornall of the Sauder School of Business, Steven N. Kaplan of the Chicago Booth School of Business, and Ilya A. Strebulaev of Stanford Business School conducted what is perhaps the most comprehensive survey of VC firms to date. In this article, they share their findings, offering details on how VCs hunt for deals, assess and winnow down opportunities, add value to portfolio companies, structure agreements with founders, and operate their own firms. These insights into VC practices can be helpful to entrepreneurs trying to raise capital, corporate investment arms that want to emulate VCs’ success, and policy makers who seek to build entrepreneurial ecosystems in their communities.

An inside look at an opaque process

Over the past 30 years, venture capital has been a vital source of financing for high-growth start-ups. Amazon, Apple, Facebook, Gilead Sciences, Google, Intel, Microsoft, Whole Foods, and countless other innovative companies owe their early success in part to the capital and coaching provided by VCs. Venture capital has become an essential driver of economic value. Consider that in 2015 public companies that had received VC backing accounted for 20% of the market capitalization and 44% of the research and development spending of U.S. public companies.

• PG Paul Gompers is the Eugene Holman Professor of Business Administration at Harvard Business School and a research associate at the National Bureau of Economic Research.
• WG Will Gornall is an assistant professor at the University of British Columbia Sauder School of Business.
• SK Steven N. Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance and the Kessenich E.P. Faculty Director of the Polsky Center for Entrepreneurship at the University of Chicago.
• IS Ilya A. Strebulaev is the David S. Lobel Professor of Private Equity and a professor of finance at the Stanford Graduate School of Business. He is also the founder of the Stanford GSB Venture Capital Initiative and a research associate at the National Bureau of Economic Research.

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Capital Budgeting and Investment Decisions

• First Online: 01 January 2015

Cite this chapter

• Uwe Götze 4 ,
• Deryl Northcott 5 &
• Peter Schuster 6  

Part of the book series: Springer Texts in Business and Economics ((STBE))

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Investment decisions are of vital importance to all companies, since they determine both their potential to succeed and their ultimate cost structure. Investments usually entail high initial cash outflows and thus tie up substantial funds. Sound investment decisions are important, therefore. Yet, due to a highly complex and rapidly changing business environment they remain a challenging management task. Effective appraisal methods are valuable tools to support investment decisions. The following chapter explains characteristics of investment projects and discusses investment planning, provides an overview of concepts and methods and the didactical approach of this book. The decision models are then used throughout the book.

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Abdel-Kader, M. G., & Dugdale, D. (2001). Evaluating investments in advanced manufacturing technology: A fuzzy set theory approach. British Accounting Review, 33 (4), 455–489.

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Saaty, T. L. (1990b). How to make a decision: The analytic hierarchy process. European Journal of Operational Research, 48 (1), 9–26.

Shank, J. K., & Govindarajan, V. (1992). Strategic cost analysis of technological investments. SLOAN Management Review, 34 (1), 39–51.

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Authors and affiliations.

Faculty of Economics and Business Administration, Technische Universität Chemnitz, Chemnitz, Germany

Faculty of Business, The Auckland University of Technology, Auckland, New Zealand

Deryl Northcott

Faculty of Business and Economics, Schmalkalden University of Applied Sciences, Schmalkalden, Germany

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Further Reading – Part I

Bacon, P. W. (1977). The evaluation of mutually exclusive investments. Financial Management, 6 (2), 55–58.

Baldwin, R. H. (1959). How to assess investment proposals. Harvard Business Review, 37 (3), 98–105.

Boulding, K. E. (1936). Time and investment. Economica, 3 (12), 196–214.

Brealey, R. A., Myers, S. C., & Allen, F. (2014). Principles of corporate finance (11th ed.). Boston: McGraw-Hill/Irwin.

Copeland, T. E., Weston, J. F., & Shastri, K. (2005). Financial theory and corporate policy (4th ed.). Boston: Addison Wesley.

Hirshleifer, J. (1958). On the theory of optimal investment decision. The Journal of Political Economy, 66 (4), 329–352.

Lutz, F. A., & Lutz, V. (1951). The theory of investment of the firm . Princeton, NJ: Princeton University Press.

Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Bradford, D. J. (2007). Corporate finance: Core principles & applications (6th ed.). Boston: McGraw-Hill/Irwin.

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Götze, U., Northcott, D., Schuster, P. (2015). Capital Budgeting and Investment Decisions. In: Investment Appraisal. Springer Texts in Business and Economics. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-662-45851-8_1

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What Is Capital Investment?

• How It Works

Capital Investments for Business

• Advantages and Disadvantages

Accounting for Capital Investments

The bottom line.

• Investing Basics

Capital Investment: Types, Example, and How It Works

Capital investment is the acquisition of physical assets by a company for use in furthering its long-term business goals and objectives. Real estate, manufacturing plants, and machinery are among the assets that are purchased as capital investments.

The capital used may come from a wide range of sources from traditional bank loans to venture capital deals.

Key Takeaways

• Capital investment is the expenditure of money to fund a company's long-term growth.
• The term often refers to a company's acquisition of permanent fixed assets such as real estate and equipment.
• Capital assets are reported as non-current assets and most are depreciated.
• The funds for capital investment can come from a number of sources, including cash on hand, though big projects are most often financed through obtaining loans or issuing stock.
• Examples of capital investments are land, buildings, machinery, equipment, or software.

Investopedia / Theresa Chiechi

How Capital Investment Works

Capital investment is a broad term that can be defined in two distinct ways:

• An individual, a venture capital group or a financial institution may make a capital investment in a business. The money can be provided as a loan or a share of the profits down the road. In this sense of the word, capital means cash.
• The executives of a company may make a capital investment in the business. They buy long-term assets such as equipment that will help the company run more efficiently or grow faster. In this sense, capital means physical assets.

In either case, the money for capital investment must come from somewhere. A new company might seek capital investment from any number of sources, including venture capital firms, angel investors , or traditional financial institutions. When a new company goes public, it is acquiring capital investment on a large scale from many investors.

An established company might make a capital investment using its own cash reserves or seek a loan from a bank. It might issue bonds or stock shares in order to finance capital investment. There is no minimum or maximum capital investment. It can range from less than $100,000 in seed financing for a start-up to hundreds of millions of dollars for massive projects undertaken by companies in capital-intensive sectors such as mining, utilities, and infrastructure.

Capital investment is meant to benefit a company in the long run, but it nonetheless can have short-term downsides.

A decision by a business to make a capital investment is a long-term growth strategy. A company plans and implements capital investments in order to ensure future growth. Capital investments generally are made to increase operational capacity, capture a larger share of the market, and generate more revenue. The company may make a capital investment in the form of an equity stake in another company's complementary operations for the same purposes.

In many cases, capital investments are a necessary and normal part of an industry. Consider an oil-drilling company that relies on heavy machinery to extract raw materials to be processed. As opposed to a law firm that will have low-to-no capital investment requirements, capital-intensive businesses usually need specific assets in order to operate.

In addition, there are strategic components for a business to consider when deciding whether or not to invest in a capital asset. For instance, consider how certain heavy machinery such as a company vehicle could be leased. Should the company be willing to incur debt and tie up capital, the company may spend less money in the long-term by incurring a capital investment as opposed to a periodic "rental" expense.

Types of Capital Investments

Companies often acquire capital investments for diversification, modernization, or business expansion. This may mean buying capital investments different from existing aspects of its business or capital investments that simply do things better than before. Some specific types of capital investments include:

• Land: Companies may buy bare land to be used for development or expansion.
• Buildings: Companies may buy existing buildings for manufacturing, storage, production, or headquarter operations.
• Assets Under Development: Companies may incur spending over time to assemble assets that may be capitalized. For example, a company can build its own building; the accumulation of charges may be considered a capital investment.
• Furniture and Fixtures: Though furniture and fixtures may be more temporary in nature, certain aspects of accounting rules result in some overlap between FFE and capital investments.
• Machines: Companies that invest in the production elements of making goods are making capital investments.
• Software Development or Computing Devices: Companies more frequently invest capital to build software; these costs now commonly qualify for capitalization and amortization over time.

Because land does not deteriorate in a similar manner compared to other capital investments, it is not depreciated.

Advantages and Disadvantages of Capital Investments

Pros of capital investments.

The advantages of capital investments can vary depending on the specific situation. However, most companies embark on capital investments for productivity.  By investing in new equipment or technology, companies can improve their efficiency, thus lower costs and increasing output. These types of investments may also improve the quality of goods produced.

Capital investments can also lead to cost savings over time. For example, a new piece of equipment may be more energy-efficient than an older model, which can result in lower utility bills. Similarly, new technology may streamline processes and reduce the need for manual labor. Last, companies may decide the long-term discounted cash flow is favorable when comparing the upfront investment of a capital investment compared to the long-term, ongoing cash outlay of a recurring expense.

By investing in their long-term assets, companies can also gain a competitive advantage in the market. This can make it more difficult for competitors to catch up and can help the company to maintain its market position over the long term. If a company is willing to take a risk and incur a large investment to strengthen its business, this may create a barrier to entry that competitors can not overcome or compete against.

Cons of Capital Investment

The preferred option for capital investment is always a company's own operating cash flow, but that may not be sufficient to cover the anticipated costs. It is more likely the company will resort to outside financing. Therefore, there is usually a little more risk to capital investments. This is especially true for capital investments that are customized or hard to liquidate; once the company has bought the capital investment, it may be hard to exit the investment.

Capital investment is meant to benefit a company in the long run, but it nonetheless can have short-term downsides. Capital investments tends to reduce earnings growth in the short term, and that never pleases stockholders of a public company. This may be especially true for capital investments that also incur operating costs (i.e. the acquisition of land will be accompanied by a potentially hefty annual property tax assessment).

In addition, if a company does not have sufficient capital on hand to make a large investment, there are downsides to each of its financing options. Issuing additional stock shares, which is often the funding option for public companies, dilutes the value of its outstanding shares. Existing shareholders generally dislike finding that their stake in the company has been reduced. Alternatively, the total amount of debt a company has on the books is closely watched by stockholders and analysts . The payments on that debt can stifle the company's further growth.

May increase productivity if capital investment is more efficient than prior methods

May result in higher quality manufactured goods

May be cheaper in the long-run when compared against rented or monthly expensed solutions

May create a barrier to entry that yields a competitive advantage

May be too expensive for the company to outright purchase on their own.

May limit or restrict short-term profitability of the company

May be accompanied by additional operating expenses

May reduce the liquidity of the company should it be difficult to sell the capital asset

Accounting practices for capital investments involve recording the cost of the asset, allocating the cost over its useful life, and carrying the investment as the difference between cost and accumulated depreciation . The accounting treatment can vary depending on the type of asset, as land is not depreciated but many other capital investments are depreciated.

The cost of the asset should be recorded in the company's accounting records. This can include the purchase price of the asset as well as any additional costs related to the purchase such as installation or transportation costs. Companies may record the fair market value for certain capital investments under certain circumstances, but capital investments must initially be recorded at cost.

If the asset has a cost that meets the company's capitalization policy, the cost of the asset will be recorded as a capital asset on the balance sheet. This allows the company to spread the cost of the asset over its useful life and to recognize the expense over time. This is the primary difference between the assets mentioned earlier and normal operating costs, as operating costs are expensed in the period they are incurred while capital investment costs are spread over time.

The useful life of a capital investment is an estimate of the number of years that the asset will be used by the company. The depreciation method used will depend on the asset and the company's accounting policies, but commonly used methods include straight-line, declining balance, and sum-of-the-years'-digits. Companies may also record impairments to reduce the value of a capital investment should a loss be incurred. In addition, whereas operating expenses may simply be stopped, companies have a series of entries to post when a capital investment is disposed of.

Example of Capital Investment

As part of its year-end financial statements, Amazon.com reported the following assets it owned for fiscal year 2021 and 2022.

This format of the balance sheet is standard where assets are reported by liquidity starting with the most liquid assets. Because capital investments are not liquid, they are often reported lower in the list.

At year-end 2022, Amazon reported a net asset balance of $186.7 billion for property and equipment. This figure is net because capital investments, aside from land, are often depreciated and reported as their cost less any accumulated depreciation. Note that this $186.7 billion is also being excluded from current assets. Because of the long-term nature of capital investments, they are reported as noncurrent assets.

What Is an Example of a Capital Investment?

When a company buys land, that is often a capital investment. Because of the long-term nature of buying land and the illiquidity of the asset, a company usually needs to raise a lot of capital to buy the asset.

How Does a Capital Investment Work?

A capital investment works based on the benefits a company may receive over a long period of time compared to the short-term investment. In theory, a company will pay a large sum of money upfront (or over time). Then, the company will receive a benefit from the asset (potentially even after it has finished paying for it). The idea is a capital investment should provide better long-term value compared to a good or service that is being purchased and used in a single accounting period.

What Is the Largest Downside to a Capital Investment?

Companies must often make a long-term financial or legal commitment when buying capital investments. This means tying up cash, getting rid of flexibility, and taking a risk that may not pan out. Whereas a company can be more nimble by paying for something smaller, a company aims to leverage a single investment to scale growth or innovate. That growth or innovation may not materialize.

Companies may decide to make capital investments as a way to innovate, modernize, and capture a competitive advantage over its competitors. This investment often requires a large sum of money, and the company often receives an illiquid asset such as land, buildings, machinery, or equipment. The accounting treatment for capital investments if often different than operating outlays as capital investments are usually depreciated.

Amazon. " Form 10-K (2022) ."

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Venture Capital Case Study Interview Guide

If you’re a prospective venture capitalist or seeking to enter the exciting world of venture capital, you’re probably familiar with the importance of case study interviews.  Venture capital firms  are keen to identify the best candidates who understand their approach and have the necessary skills to work alongside entrepreneurs.

In this comprehensive guide, we will cover everything you need to know to ace your  venture capital case study  interview. We’ll provide insights into the venture capital  interview process  and discuss the most common interview questions. We’ll also share our tips on how to prepare and master case studies, analyze industry trends, and navigate  technical questions  and  financial modeling  exercises.

Key Takeaways

• Successful  venture capitalists  need an in-depth understanding of the industry and current  market trends .
• Case study interviews are designed to test your analytical and problem-solving skills and your ability to work with teams and entrepreneurs.
• Some of the most  common venture capital interview questions  are aimed at evaluating your fit for the role and the firm.
• Valuation  and  investment thesis  play a crucial role in venture capital decision-making.
• Thorough preparation, including studying sample questions and frameworks, is essential for success in  VC case study  interviews.

Understanding the Venture Capital Interview Process

Before diving into case study interviews, it is essential to have a comprehensive understanding of the venture capital  interview process . The process typically begins with an initial screening, where the candidate’s qualifications and skills are assessed. If the candidate passes the initial screening, the firm may conduct a follow-up interview, which may be conducted by a more senior member of the team.

In some cases, firms may also require candidates to complete an assignment or provide a writing sample. Following this round of interviews, successful candidates are invited to participate in final rounds, which may involve meetings with additional members of the team or a more in-depth panel presentation.

One of the key components of the venture capital  interview process  is the ability to effectively articulate your thoughts and ideas. Strong communication skills, including the ability to present complicated information clearly and succinctly, are essential for success in this industry. Additionally, candidates should be prepared to demonstrate their analytical skills, their understanding of industry trends, and their ability to work collaboratively as part of a team.

When  preparing for a venture  capital interview, it is essential to research the firm thoroughly and familiarize yourself with their investment philosophy, portfolio companies, and recent activity. A strong understanding of the firm’s focus areas and investment strategy can help you tailor your responses to their specific needs and increase your chances of success.

VC Interview Questions

VC interview questions  are designed to assess a candidate’s fit with the firm and their qualifications for the role. Common  VC interview questions  may include:

• Why do you want to work in venture capital?
• What do you think differentiates our firm from other  venture capital firms ?
• Can you discuss a deal you found particularly interesting and why?
• How would you value a company?
• What are some current industry trends?

By understanding the  venture capital interview  process and preparing thoroughly, you can increase your chances of success in this highly competitive industry.

Preparing for a Venture Capital Case Study Interview

Preparation is key to delivering a standout performance in a  venture capital case study  interview. Developing an effective strategy requires thorough research and practice. Here are some tips to help you prepare:

Research the VC Firm

Start by researching the  VC  firm you will be interviewing with. This will provide insights into their investment focus, ethos, and portfolio companies. Analyse their website, social media accounts, news articles, and other sources of information. This will help you understand the firm’s investment criteria and identify areas where you can align your background and experience with their interests.

Practice With Case Studies

Case study interviews are a crucial part of the  venture capital interview  process. Practise with mock case studies and analyse how successful  VC funds  have invested in real-world scenarios. This will enhance your analytical abilities and problem-solving skills, bringing you closer to the mindset of a  VC  analyst or associate.

Be Prepared to Frame Your Approach

In a  venture capital case study  interview, there is often no one “right” answer to a problem. Interviewers are more interested in your analytical approach and thought process. They want to see that you have the skills to break down complex problems and communicate your thinking in a clear and concise manner.

Be prepared to frame your approach by breaking down the problem, identifying key assumptions, and narrowing in on the key issues. Developing a structure can help ensure your analysis is comprehensive and well-organized.

Be Ready for Technical Questions

VC  interviews often include questions about technical topics related to venture capital and finance. Brush up on key concepts such as  valuation , term sheets, and financial modelling. This will allow you to discuss these topics articulately during the interview and showcase your expertise in the field.

“By failing to prepare, you are preparing to fail.” – Benjamin Franklin

By following these strategies, you will be better prepared to tackle a  venture capital case study interview . Remember to keep calm, stay focused, and communicate your thoughts clearly and logically. Always be ready to justify your assumptions and pivot your approach based on new information provided during the interview.

Common Venture Capital Interview Questions

In order to prepare for your  venture capital interview , it’s crucial to have an understanding of the common questions that may be asked. These questions are tailored to evaluate your fit for the role and the firm.

Specific Questions

One common question focuses on your experience as it relates to the venture capital industry. Interviewers often want to know how you’ve gained knowledge and what relevant experiences you’ve had. Another question centers around what value you could bring to the firm and whether you have any specific expertise that would be beneficial to their investment strategy.

Interviewer Expectations

Interviewers are looking  for candidates who have a strong understanding of the industry and the firm’s investment focus. They want to see evidence of strong analytical skills, critical thinking, and an ability to identify and capitalize on excellent investment opportunities. Additionally, they look for candidates who are adaptable and can work collaboratively within the firm.

“One common question centers around what value you could bring to the firm and whether you have any specific expertise that would be beneficial to their investment strategy.”

Mastering the Case Study Interview

During a  venture capital case study interview , the interviewer typically presents a business case related to the industry or market to assess your analytical, problem-solving, and communication skills. A  case study interview  is your opportunity to showcase your ability to analyze a problem or situation, evaluate potential solutions, and develop a coherent and persuasive argument.

Preparing for a  case study interview  involves understanding the case study methodology and identifying the key elements of the problem to solve. Generally, case study interviews follow a structured format:

• The interviewer presents the case study, along with any relevant background information and data.
• You have time to review and analyze the case study before presenting your analysis and proposed solution(s).
• You present your analysis and proposed solution(s) to the interviewer.
• The interviewer may ask follow-up questions to test your assumptions, methodology, and problem-solving skills.

To succeed in a  case study interview , it’s crucial to follow a structured approach and demonstrate a thorough understanding of the problem and its context. In addition, your analysis should be supported by credible data and logical reasoning.

One effective framework for structuring your case study analysis is the “Issue-Tree” method.

Issue-Tree Method

The issue-tree method involves breaking down a complex problem into smaller, manageable components, and identifying the cause-and-effect relationships between them. The framework allows you to analyze the problem systematically and develop a clear, structured argument.

As shown in the table, the issue-tree method involves identifying the problem, breaking it down into smaller “causes” and developing “hypotheses” for each cause. You then gather relevant “data” to test each hypothesis, and derive “conclusions” based on the data.

Remember to emphasize your communication and presentation skills during the interview. You should be able to present your analysis and solution(s) in a clear, concise, and persuasive manner.

Understanding the Venture Capital Industry and Market Trends

Having a deep understanding of the venture capital industry and staying on top of the latest  market trends  can give you a significant advantage in a case study interview. The venture capital industry is driven by  venture capital firms  and  venture capitalists  who invest in startups with high growth potential in exchange for equity.

According to Pitchbook, venture capital firms invested over £10 billion in the UK in 2020, despite the challenges posed by the pandemic. While the first quarter of 2021 saw a decline in venture capital investment, due to uncertainty related to Brexit and the pandemic, the industry rebounded in the following months.

It’s important to stay up-to-date with  market trends  to understand which industries and sectors are currently receiving the most investment, such as healthcare, fintech, and sustainability. By keeping tabs on market trends, you can develop a perspective on where the industry is headed and which startups are most likely to succeed.

“The key players in the industry include Accel, Sequoia Capital, Index Ventures, and more. It’s crucial to research these firms and the types of startups they specialize in, in order to tailor your preparation for your interview.” – Jonathan Davies,  VC Associate

Valuation and Investment Thesis in Venture Capital

Valuation  and  investment thesis  play a crucial role in making sound venture capital investments. Before investing in a startup,  venture capitalists  need to determine its valuation and align it with the firm’s  investment thesis . Valuation is the process of determining a company’s worth based on its assets, market potential, and future growth prospects. A startup’s valuation can also be influenced by market trends and competition.

Venture capitalists develop investment theses to guide their investment decisions. An investment thesis is a set of criteria that a startup must meet to be considered for investment. Factors such as industry, market potential, management team, and technology can influence a venture capital firm’s investment thesis. The investment thesis also shapes the firm’s portfolio and helps attract investors to its  VC funds .

When considering investment opportunities, venture capitalists need to ensure that a startup’s vision aligns with the firm’s investment thesis. Investing in a startup that does not align with the firm’s investment thesis could lead to strategic misalignment and poor returns.

Valuation Methodologies

Venture capitalists use various methodologies to value startups. The most common valuation method is the discounted cash flow (DCF) analysis. The DCF method involves estimating a startup’s future cash flows and discounting them back to their present value.

Another commonly used valuation method is the market-based approach, which compares a startup’s valuation to that of similar companies in the market. The market-based approach involves using multiples such as price-to-earnings ratio (P/E ratio) or price-to-sales ratio (P/S ratio) to determine a startup’s valuation.

Factors to Consider in Developing an Investment Thesis

Developing a sound investment thesis requires careful consideration of various factors. These include the target industry, stage of the startup, management team, competition, and market potential. A thorough understanding of these factors can help venture capitalists make informed investment decisions.

Navigating Technical Questions and Financial Modeling

Technical questions  and  financial modeling  are crucial components of a  venture capital case study interview  that test your analytical and strategic thinking skills. As a  VC associate , you’ll be expected to evaluate startups, assess market opportunities and risks, and develop investment strategies that align with your firm’s vision.

Here are some tips for approaching  technical questions  and  financial modeling  exercises:

• Understand the problem:  Read the case study carefully, and make sure you understand the goals, constraints, and relevant data points.
• Organize your thoughts:  Create a logical outline or framework for your analysis, and break down complex problems into smaller, manageable parts.
• Use data wisely:  Use financial models, graphs, and other visual aids to communicate your findings and support your arguments.
• Be flexible:  Be open to new ideas, alternate solutions, and different perspectives. Venture capital is an ever-changing industry, and being adaptable is key.

Here are some common types of technical questions and financial modeling exercises:

To prepare for technical questions and financial modeling exercises, try practicing with sample case studies and reviewing industry reports and market research. Build your analytical toolkit with courses, books, and online resources, and stay up-to-date on the latest trends and technologies in the venture capital industry.

With this comprehensive guide, you are now equipped with all the necessary tools and insights to succeed in your venture capital case study interview. Remember to understand the interview process, thoroughly prepare for the case study interview, and master the common interview questions. It’s also important to stay up-to-date with industry trends and understand the valuation and investment thesis process. Finally, be confident in navigating technical questions and financial modeling exercises. Good luck with your venture capital interview!

What is a venture capital case study interview?

A venture capital case study interview is an interview format commonly used by venture capital firms to assess a candidate’s ability to evaluate investment opportunities. It typically involves analyzing a hypothetical or real-life investment scenario and presenting recommendations based on your analysis.

How should I prepare for a venture capital case study interview?

To prepare for a venture capital case study interview, familiarize yourself with the industry and its trends, practice analyzing case studies, and develop a structured approach to problem-solving and decision-making. You should also be comfortable with financial modeling, valuation techniques, and presenting your findings in a clear and concise manner.

What are some common venture capital interview questions?

Common venture capital interview questions  include inquiries about your investment thesis, previous investment experience, knowledge of the industry, and how you would evaluate a potential investment opportunity. Interviewers may also ask behavioral questions to assess your ability to work in a team and overcome challenges.

How do I demonstrate my industry knowledge in a venture capital interview?

To demonstrate your industry knowledge in a venture capital interview, stay updated on market trends, follow industry blogs and news outlets, and research the investment portfolios and strategies of the venture capital firms you are interviewing with. Being able to articulate your understanding of industry dynamics and align it with the firm’s investment thesis will make a strong impression.

What should I expect during a venture capital case study interview process?

During a venture capital case study interview, you can expect to receive a case study prompt or scenario, analyze the given information, and present your recommendations. The interviewers may ask you clarifying questions, challenge your assumptions, and assess your ability to think critically and make sound investment decisions.

How can I best showcase my analytical skills in a venture capital case study interview?

To showcase your analytical skills in a venture capital case study interview, demonstrate a structured approach to problem-solving, use relevant financial models or frameworks to support your analysis, clearly articulate your assumptions, and explain the rationale behind your recommendations. It’s also important to communicate your findings in a concise and persuasive manner.

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Table of contents.

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Case Analysis on Capital Investment Decision

This paper is about to solve a case analysis of how to take decision for taking any capital investment of a new project. Here I have tried to show what method should follow or review before taking any long term capital spending decision.

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The Private Equity Case Study: The Ultimate Guide

If you're new here, please click here to get my FREE 57-page investment banking recruiting guide - plus, get weekly updates so that you can break into investment banking . Thanks for visiting!

The private equity case study is an especially intimidating part of the private equity recruitment process .

You’ll get a “case study” in virtually any private equity interview process , whether you’re interviewing at the mega-funds (Blackstone, KKR, Apollo, etc.), middle-market funds , or smaller, startup funds.

The difference is that each one gives you a different type of case study, which means you need to prepare differently:

What Should You Expect in a Private Equity Case Study?

There are three different types of “case studies”:

• Type #1: A “ paper LBO ,” calculated with pen-and-paper or in your head, in which you build a simple leveraged buyout model and use round numbers to guesstimate the IRR.
• Type #2: A 1-3-hour timed LBO modeling test , either on-site or via Zoom and email. This is a pure speed test , so proficiency in the key Excel shortcuts and practice with many modeling tests are essential.
• Type #3: A “take-home” LBO model and presentation, in which you might have a few days up to a week to pick a company, research it, build a model, and make a recommendation for or against an acquisition of the company.

We will focus on the “take-home” private equity case study here because the other types already have their own articles/tutorials or will have them soon.

If you’re interviewing within the fast-paced, on-cycle recruiting process with large funds in the U.S. , you should expect timed LBO modeling tests (type #2).

If the firm interviews dozens of candidates in a single weekend, there’s no time to give everyone open-ended case studies and assess them.

You might also get time-pressured LBO modeling tests in early rounds in other financial centers, such as London .

The open-ended case studies – type #3 – are more common at smaller funds, in off-cycle recruiting, and outside the U.S.

Although you have more time to complete them, they’re significantly more difficult because they require critical thinking skills and outside research.

One common misconception is that you “need” to build a complex model for these case studies.

But that is not true at all because they’re judging you mostly on your investment thesis , your presentation, and your ability to answer questions afterward.

No one cares if your LBO model has 200 rows, 500 rows, or 5,000 rows – they care about how well you make the case for or against the company.

This open-ended private equity case study is often the final step between the interview and the job offer, so it is critically important.

The Private Equity Case Study, in Parts

This is another technical tutorial, so I’ve embedded the corresponding YouTube video below:

Table of Contents:

• 4:32: Part 1: Typical Case Study Prompt
• 6:07: Part 2: Suggested Time Split for a 1-Week Case Study
• 8:01: Part 3: Screening and Selecting a Company
• 14:16: Part 4: Gathering Data and Doing Industry Research
• 22:51: Part 5: Building a Simple But Effective Model
• 26:32: Part 6: Drafting an Investment Recommendation

Files & Resources:

• Case Study Prompt (PDF)
• Private Equity Case Study Slides (PDF)
• Cars.com – Highlighted 10-K (PDF)
• Cars.com – Investor Presentation (PDF)
• Cars.com – Excel Model (XL)
• Cars.com – Investment Recommendation Presentation (PDF)

We’re going to use Cars.com in this example, which is one of the many case studies in our Advanced Financial Modeling course:

Advanced Financial Modeling

Learn more complex "on the job" investment banking models and complete private equity, hedge fund, and credit case studies to win buy-side job offers.

The full course includes a detailed, step-by-step walkthrough rather than this summary, an additional advanced LBO model, and other complex case studies for investment banking, hedge funds, and credit.

Part 1: Typical Private Equity Case Study Prompt

In some cases, they’ll give you a company to analyze, but in others, you’ll have to screen for companies yourself and pick one.

It’s easier if they give you the company and the supporting documents like the Information Memorandum , but you’ll also have less time to complete the case study.

The prompt here is very open-ended: “We like these types of deals and companies, so pick one and present it to us.”

The instructions are helpful in one way: they tell us explicitly not to build a full 3-statement model and to focus on the market and strategy rather than an “extremely complex model.”

They also hint very strongly that the model must include sensitivities and/or scenarios:

Part 2: Suggested Time Split for a 1-Week Private Equity Case Study

You have 7 days to complete this case study, which may seem like a lot of time.

But the problem is that you probably don’t have 8-12 hours per day to work on this.

You’re likely working or studying full-time, which means you might have 2-3 hours per day at most.

So, I would suggest the following schedule:

• Day #1: Read the document, understand the PE firm’s strategy, and pick a company to analyze.
• Days #2 – 3: Gather data on the company’s industry, its financial statements, its revenue/expense drivers, etc.
• Days #4 – 6: Build a simple LBO model (<= 300 rows), ideally using an existing template to save time.
• Day #7: Outline and draft your presentation, let the numbers drive your decisions, and support them with the qualitative factors.

If the presentation is shorter (e.g., 5 slides rather than 15) or longer, you could tweak this schedule as needed.

But regardless of the presentation length, you should spend MORE time on the research, data gathering, and presentation than on the LBO model itself.

Part 3: Screening and Selecting a Company

The criteria are simple and straightforward here: “The firm aims to find undervalued companies with stagnant or declining core businesses that can be acquired at reasonable valuation multiples and then turn them around via restructuring, divestitures , and add-on acquisitions.”

The industry could be consumer, media/telecom, or software, with an ideal Purchase Enterprise Value of $500 million to $1 billion (sometimes up to $2 billion).

Reading between the lines, I would add a few criteria:

• Consistent FCF Generation and 10-20%+ FCF Yields: Strategies such as turnarounds and add-on acquisitions all require cash flow. If the company doesn’t generate much Free Cash Flow , it will have to issue Debt to fund these strategies, which is risky because it makes the deal very dependent on the exit multiple.
• Relatively Lower EBITDA Multiples: If the company has a “stagnant or declining” core business, you don’t want to pay 20x EBITDA for it. An ideal range might be 5-10x, but 10-15x could be OK if there are good growth opportunities. The IRR math also gets tougher at high EBITDA multiples because the maximum Debt in most deals is 5-6x.
• Clean Financial Statements and Enough Detail for Revenue and Expense Projections: You don’t want companies with 2-page-long Cash Flow Statements or Balance Sheets with 100 line items; you can’t spare the time required to simplify and consolidate these statements. And you need some detail on the revenue and expenses because forecasting revenue as a simple percentage Year-Over-Year (YoY) growth rate is a bad idea in this context.

We used this process to screen for companies here:

• Step 1: Do a high-level screen of companies in these 3 sectors based on industry, Equity Value or Enterprise Value, and geography.
• Step 2: Quickly review the list of ~200 companies to narrow the sector.
• Step 3: After picking a specific sector, narrow the choices to the top few companies and pick one of them.

In software , many of the companies traded at very high multiples (30x+ EBITDA), and others had negative EBITDA , so we dropped this sector.

In consumer/retail , the companies had more reasonable multiples (5-10x), but most also had low margins and weak FCF generation.

And in media/telecom , quite a few companies had lower multiples, but the FCF math was challenging because many companies had high CapEx requirements (at least on the telecom side).

We eliminated companies with very high multiples, negative EBITDA, and exorbitant CapEx, which left this set:

Within this set, we then eliminated companies with negative FCF, minimal information on revenue/expenses, somewhat-higher multiples, and those whose businesses were declining too much (e.g., 20-30% annual declines).

We settled on Cars.com because it had a 9.4x EBITDA multiple at the time of this screen, a declining business with modest projected growth, 25-30% margins, and reasonable FCF generation with FCF yields between 10% and 15%.

If you don’t have Capital IQ for this exercise, you’ll have to rely on FinViz and use P / E multiples as a proxy for EBITDA multiples.

You can click through to each company to view the P / FCF multiples, which you can flip around to get the FCF yields.

In this case, don’t even bother looking for revenue and expense information until you have your top 2-3 candidates.

Part 4: Gathering Data and Doing Industry Research

Once you have the company, you can spend the next few days skimming through its most recent annual report and investor presentation, focusing on its financial statements and revenue/expense drivers.

With Cars.com, it’s clear that the company’s “Dealer Customers” and Average Revenue per Dealer will be key drivers:

The company also has significant website traffic and earns advertising revenue from that, but it’s small next to the amount it earns from charging car dealers to use its services:

It’s clear from this quick review that we’ll need some outside research to estimate these drivers, as the company’s filings and investor presentation have little.

Fortunately, it’s easy to Google the number of new and used car dealers in the U.S. and estimate the market size and share like that:

The company’s market share has been declining , and we expect that trend to continue, but it’s not clear how rapid the decline will be.

Consumers are increasingly buying directly from other consumers, and dealers have less reason to use the company’s marketplace services than in past years.

We create an area for these key drivers, with scenarios for the most uncertain one:

You might be wondering why there’s no assumed uptick in market share since this is supposed to be a “turnaround” case study.

The short answer is that we think the company is unlikely to “turn around” its core business in this time frame, so it will have to move into new areas via bolt-on acquisitions .

For example, maybe it could acquire smaller firms that sell software and services to dealers, or it could acquire physical or online car dealerships directly.

Another option is to acquire companies that can better monetize Cars.com’s large and growing web traffic – such as companies that sell auto finance leads.

As part of this process, we also need to research smaller companies to acquire, but there isn’t much to say about this part.

It comes down to running searches on Capital IQ for smaller companies in related industries and entering keywords like “auto” in the business description field.

In terms of the other financial statement drivers , many expenses here are simple percentages of revenue, but we could also link them to the employee count.

We also link the website traffic to the sales & marketing spending to capture the spending required for growth in that area.

Finally, we need to input the financial statements for the company, which is not that hard since they’re already fairly clean:

It might be worth consolidating a few items here, but the Income Statement and partial Cash Flow Statement are mostly fine, which means the Excel versions are close to the ones in the annual report.

Part 5: Building a Simple But Effective Model

The case study instructions state that a full 3-statement model is not necessary – but even if they had not, such a model would rarely be worthwhile.

Remember that LBO models, just like DCF models , are based on cash flow and EBITDA multiples ; the full statements add almost nothing since you can track the Cash and Debt balances separately.

In terms of model complexity, a single-sheet LBO with 200-300 rows in Excel is fine for this exercise.

You’re not going to get “extra credit” for a super-complex LBO model that takes days to understand.

The key schedules here are:

• Transaction Assumptions – Including the purchase price, exit assumptions, scenarios, and tranches of debt. Skip the working capital adjustment unless they specifically ask for it. For more on these nuances, see our coverage of Enterprise Value vs. purchase price and cash-free debt-free deals .
• Sources & Uses – Short and simple but required to calculate the Investor Equity.
• Revenue, Expense, and Cash Flow Drivers – These don’t need to be super-complex; the goal is to go beyond projecting revenue as a simple percentage growth rate.
• Income Statement and Partial Cash Flow Statement – The goal is to calculate Free Cash Flow because that drives Debt repayment and Cash generation in an LBO.
• Add-On Acquisitions – These are part of the “turnaround strategy” in this deal, so they’re quite important.
• Debt Schedule – This one is quite simple here because the deal is not dependent on financial engineering.
• Returns Calculations – The IPO vs. M&A exit options add a bit of complexity.
• Sensitivity Tables – It’s difficult to draft the investment recommendation without these.

Skip anything that makes your life harder, such as circular references in Excel (to avoid these, use the beginning Cash and Debt balances to calculate interest).

We pay special attention to the add-on acquisitions here, with support for their revenue and EBITDA contributions:

The Debt Schedule features a Revolver, Term Loans, and Subordinated Notes:

The Returns Calculations are also simple; we do assume a bit of Multiple Expansion because of the company’s higher growth rate by the end:

Could we simplify this model even further?

I don’t think the M&A vs. IPO exit options mentioned above are necessary, and we could also drop the “Growth” vs. “Value” options for the add-on acquisitions:

Especially if we recommend against the deal, it’s not that important to analyze which type of add-on acquisition works best.

It would be more difficult to drop the scenarios and Excel sensitivity tables , but we could restructure them a bit and fold the scenario into a sensitivity table.

All investing is probabilistic, and there’s a huge range of potential outcomes – so it’s difficult to make a serious investment recommendation without examining several outcomes.

Even if we think this deal is spectacular, we must consider cases in which it goes poorly and how we might reduce those risks.

Part 6: Drafting an Investment Recommendation

For a 15-slide recommendation, I would recommend this structure:

• Slides 1 – 2: Recommendation for or against the deal, your criteria, and why you selected this company.
• Slides 3 – 7: Qualitative factors that support or refute the deal (market, competition, growth opportunities, etc.). You can also explain your proposed turnaround strategy, such as the add-on acquisitions, here.
• Slides 8 – 13: The numbers, including a summary of the LBO model, multiples vs. comps (not a detailed valuation), etc. Focus on the assumptions and the output from the sensitivity tables.
• Slide 14: Risk factors for a positive recommendation, and the counter-factual (“what would change your mind?”) for a negative one. You can also explain the potential impact of each risk on the returns and how you could mitigate these risks.
• Slide 15: Restate your conclusions from Slide 1 and present your best arguments here. You could also change the slide formatting or visuals to make it seem new.

“OK,” you say, “but how do you actually make an investment decision?”

The easiest method is to set criteria for the IRR or multiple of invested capital in each case and say, “Yes” if the deal achieves those numbers and “No” if it does not.

For example, maybe the targets are a 30% IRR in the Upside case, a 20% IRR in the Base case, and a 1.0x multiple in the Downside case (i.e., avoid losing money).

We do achieve those numbers in this deal, but the decision could go either way because the deal is highly dependent on the add-on acquisitions.

Without these acquisitions, the deal does not work; the IRR falls by 10%+ across all the scenarios and turns negative in the Downside case.

We need at least 5 good acquisition candidates matching very specific financial profiles ($100 million Purchase Enterprise Value and a 15x EBITDA purchase multiple with 10% revenue growth or 5x EBITDA with 3% growth).

The presentation includes some examples of potential matches:

While these examples are better than nothing, the case is not that strong because:

• Most of these companies are too big or too small to fit into the strategy proposed here of ~$100 million in annual acquisitions.
• The acquisition strategy is unclear ; acquiring and integrating dealerships (even online ones) would be very, very different from acquiring software/data/media companies.
• And since the auto software market is very niche, there’s probably not a long list of potential acquisition candidates beyond the few we found.

We end up saying, “Yes” in this recommendation, but you could easily reach the opposite conclusion because you believe the supporting data is weak.

In short: For a 1-week open-ended case study, this approach is fine, but this specific deal would probably not stand up to a more detailed on-the-job analysis.

The Private Equity Case Study: Final Thoughts

Similar to time-pressured LBO modeling tests, you can get better at the open-ended private equity case study by “putting in the reps.”

But each rep is more time-consuming, and if you have a demanding full-time job, it may be unrealistic to complete multiple practice case studies before the real thing.

Also, even with significant practice, you can’t necessarily reduce the time required to research an industry and specific companies within it.

So, it’s best to pick companies and industries you already know and have several Excel and PowerPoint templates ready to go.

If you’re targeting smaller funds that use off-cycle recruiting, the first part should be easy because you should be applying to funds that match your industry/deal/client background.

And if not, you can always make a lateral move to a bulge bracket bank and interview at the larger funds if you prefer the private equity case study in “speed test” form.

If you liked this article, you might be interested in:

• Private Equity Value Creation : Equally Viable Alternative to PE Deal Teams?
• The Growth Equity Case Study: Real-Life Example and Tutorial
• The Full Guide to Healthcare Private Equity, from Careers to Contradictions
• Healthcare Investment Banking: The Best Group to Check Into When Human Civilization is Collapsing?

About the Author

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street . In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.

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Valuing Capital Investment Projects – Case Solution

This case study is a collection of issues, which introduces students to the concept of discounted cash flow analysis in the evaluation of capital budgeting problems.

​W. Carl Kester Harvard Business School ( 298092-PDF-ENG ) Dec 30, 1997 (Revision: Dec 4, 1998)

Case questions answered:

Please provide an Excel file with the calculations for this case study.

Not the questions you were looking for? Submit your own questions & get answers .

Valuing Capital Investment Projects Case Answers

This case solution includes an Excel file with calculations.

Download the full Excel calculation for the Valuing Capital Investment Projects Case Study:

Download Excel file: Valuing Capital Investment Projects

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Investment Portfolio Case Competition Overview

February 9, 2024 event organized by:.

• Cornell’s Parker Center for Investment Research
• Johnson Investment Management Club
• Cornell Financial Engineering Manhattan (CFEM)

2024 Case Topic: Private Wealth and Bitcoin

Competitors will review a case study of a fictional young family with a large stake in Bitcoin shares. The family faces life changes and is currently seeking a plan to manage the BTC position and plan for the family’s financial future. After careful study of case materials and investment analysis, teams will present innovative diversification ideas, an asset allocation plan, and an implementation strategy, all supported by rigorous testing.