Positive NPV is the beginning, not the decision. A capital budgeting simulation makes students live with what comes next. They must fund the project, preserve liquidity through construction, account for working capital and depreciation, manage maturities, and explain dilution. The strongest lesson connects the original appraisal to realized operations and final value.
Use the simulation as a sequence of linked questions. Is the project expected to create value? Can the company finance it safely? How does commissioning appear in the statements? Did the expected benefit arrive? Who received the resulting value?
Establish the NPV decision rule
Net present value is the present value of expected incremental cash inflows minus the present value of incremental cash outflows. OpenStax explains that cash flows from different periods must be translated to a common present value before comparison. Under the standard rule, a positive-NPV independent project adds value under the stated cash-flow and discount-rate assumptions.
Provide students with the project’s incremental cash-flow schedule and a disclosed minimum required return. Require them to show the timing convention and calculate the following.
NPV = CF0 + CF1 / (1 + r)^1 + … + CFt / (1 + r)^t
Students should identify assumptions such as capital cost, commissioning date, operating savings, useful life, terminal value, and discount rate.
Do not let a positive number end the analysis. Ask how sensitive the conclusion is to one plausible adverse change and whether limited capital creates a choice among positive-NPV projects.
Scroll sideways inside the graph and table to see all the data. You can also focus it and use the left and right arrow keys.
Try a fictional project that costs $10,000 today and returns $4,500 at the end of each of the next three years. Use a 10% annual required return, no terminal value, and no other project cash flows. These are teaching assumptions, not ClassTycoon scenario settings.
| Date | Cash flow | Present value | Cumulative present value |
|---|---|---|---|
| Year 0 | -$10,000.00 | -$10,000.00 | -$10,000.00 |
| Year 1 | $4,500.00 | $4,090.91 | -$5,909.09 |
| Year 2 | $4,500.00 | $3,719.01 | -$2,190.08 |
| Year 3 | $4,500.00 | $3,380.92 | $1,190.83 |
Using unrounded values, NPV is $1,190.83. Rounded table entries may differ by one cent when added. If each annual inflow falls to $3,500, NPV becomes negative $1,296.02. A positive base-case NPV still leaves the separate question of how to fund the initial payment.
Separate project value from financing
Project appraisal and financing interact through liquidity and owner outcomes, but they are not the same calculation. A valuable project does not become more valuable merely because it is funded with debt, and an unattractive project is not repaired by issuing equity.
Give teams three funding questions.
- How much cash is needed before the project produces benefits?
- What payment or dilution obligations does each source create?
- What liquidity buffer remains under an adverse operating case?
Debt creates interest and maturity obligations. Short debt may mature before benefits fully arrive. Longer debt extends interest commitments. Equity avoids scheduled repayment but dilutes original ownership.
Require students to state the funding mix separately from the invest-or-reject recommendation. This prevents them from treating maximum borrowing or zero dilution as automatic goals.
Make equity dilution numerical
Students often describe dilution as a vague disadvantage. Give it a denominator. Calculate the new ownership share and percentage remaining with original owners using the scenario’s method.
Then distinguish percentage ownership from value. Original owners can hold a smaller percentage of a larger, more valuable company. Conversely, avoiding dilution does not help them if excessive debt or missed investment destroys value.
Ask teams to compare original-owner value under debt and equity plans, including distributions when relevant. They should identify the assumptions about issue price, project value, interest, and repayment timing.
Trace commissioning through the statements
When a project starts, the cash flow usually appears before the full income-statement effect. Students should trace the sequence using the scenario’s accounting rules.
- Investing cash outflow reduces cash and creates construction or project assets.
- On commissioning, the asset enters PP&E or the specified in-service category.
- Depreciation allocates cost across its useful life and reduces accounting profit without being a current cash payment.
- Operating benefits affect revenue, cost, quality, or capacity as defined.
- Working capital can absorb cash through receivables or inventory even when the income statement shows profit.
- Debt issuance and repayment appear in financing cash flows. Interest affects profit and cash under the stated timing.
Ask students to reconcile one Round from beginning cash to ending cash. A profitable company can still face a liquidity problem when receivables, inventory, investment, or debt maturity use cash.
Compare appraisal with realized variance
Once the project is operating, return to the original memo. Compare expected incremental benefit with realized benefit. The difference is a project variance, but students must diagnose it with operational evidence.
Separate at least three explanations. The market differed from the appraisal, the project did not deliver its expected operating effect, or the Team Company made other price and production choices that obscured the benefit. Do not assign all variance to "bad forecasting" without tracing the mechanism.
Ask whether the original decision was reasonable with the information available at the time. A good decision can have a poor realized outcome, and a poor process can be rescued by favorable conditions. This distinction is central to fair assessment.
Run the lesson in five phases
Phase 1: Market and statement baseline
Before projects, students trace a credit sale through revenue, receivables, and later cash collection. Establish capacity, costs, working capital, and starting liquidity.
Phase 2: Project appraisal and funding
Teams calculate NPV, select at most the permitted projects, choose debt term or equity, and show the post-funding cash buffer. Require a downside case.
Phase 3: Construction and commissioning
Students track project cash outflow, in-service timing, PP&E, depreciation, and operating effects. They should not count benefits before the scenario makes them available.
Phase 4: Repayment and second allocation
Teams review interest coverage, debt maturity, remaining cash, dilution, and realized project variance. If another project is possible, they must account for the existing balance sheet.
Phase 5: Valuation and recommendation
Students recommend invest, hold, delever, or distribute using original-owner book equity, remaining project value, and distributions under the scenario’s valuation bridge. The final recommendation should cite the complete path, not one Round’s rank.
Debrief with a finance evidence chain
Choose two Team Companies that selected different funding mixes or projects. Compare appraisal, cash buffer, commissioning, realized benefit, debt service, ownership, and final value. Ask the following.
- Which project had a positive NPV under the disclosed required return?
- What cash need occurred before the benefit arrived?
- How did debt maturity or equity dilution change original-owner outcomes?
- Where did profit and cash move differently, and why?
- Did realized benefit support the original appraisal?
- Which final recommendation follows from the valuation bridge?
Keep financing costs and project operating value conceptually distinct. When both change, ask students to identify which part of the evidence chain supports each claim.
Assess a board recommendation
Use a team board memo and an individual reconciliation. The memo should contain the project NPV, key assumptions, funding mix, downside liquidity, realized variance, and final recommendation. The individual task should trace one transaction across the income statement, balance sheet, and cash flow statement.
Grade calculation accuracy, assumption transparency, statement consistency, and judgment. Do not grade the final ranking directly. A team that preserves high cash by rejecting every positive-NPV project has not necessarily allocated capital well. A team that invests aggressively without a workable financing plan has not solved the whole problem either.
ASEE research describes a graduate capital-budgeting course in which students built simulation models and used them to compare project ranking and selection methods. Your course may use a provided model rather than student programming, but the same discipline applies. Simulation is a tool for examining assumptions and decisions, not a substitute for finance reasoning.
Use Heat-Pump Factory as the finance context
Capital Allocation: Heat-Pump Factory is an eight-Round ClassTycoon Pro scenario for Undergraduate Core Finance, designed for about 120 minutes. Team Companies forecast demand, plan production, appraise factory projects, issue fixed-rate debt or equity, manage repayment and dividends, reconcile statement effects, and make a final recommendation.
The scenario offers three immutable paths: Stable Growth, Rate Shock, and Demand Transition. It discloses complete timelines to instructors while students receive current conditions and one-Round advance signals. Its designed objectives include project NPV, financing tradeoffs, three-statement reconciliation, project variance, and original-owner Shareholder Value.
Heat-Pump Factory is available now. Real instructor and student pilot validation remains to be completed. Inspect the complete decision and evidence flow in the simulation library and review current access on Pricing.
Frequently asked questions
Should students always accept a positive-NPV project?
The standard rule supports accepting an independent positive-NPV project under the stated assumptions, but capital constraints, mutually exclusive choices, liquidity, and estimation risk can require further analysis. Students should make those conditions explicit.
Does debt avoid dilution?
Debt does not issue ownership, but it creates interest and repayment obligations. Compare original-owner value, liquidity, and risk rather than treating either debt or equity as costless.
Why can profit rise while cash falls?
Revenue may be recorded before collection, inventory can use cash before sale, capital investment is not expensed immediately, and debt repayment uses cash without reducing operating profit. Trace the statements using the scenario’s timing rules.