CFA Corporate Issuers Notes: Capital Budgeting, NPV, IRR and Working Capital [Level 1]

These CFA corporate issuers notes explain how a company is governed and how it raises and spends money. Corporate Issuers carries a 6 to 9 percent weight in the 2026 CFA Level 1 exam, according to CFA Institute. That range equals roughly 11 to 16 of the 180 exam questions. These notes cover capital budgeting, NPV and IRR, working capital and the cash conversion cycle, plus liquidity, capital structure and governance. Build the rest of your plan from our CFA Level 1 notes hub.

CFA corporate issuers: what the topic covers

Corporate issuers covers how a company is governed, how it raises money, and how it spends money. Managers choose long-term projects with capital budgeting, fund daily operations with working capital, and set the mix of debt and equity. At Level 1, the exam tests decision rules and formulas.

Governance comes first because shareholders own the company while managers run it, and their interests can drift apart. A board closes that gap: it hires and fires the chief executive, approves strategy, and watches over risk.

The capital budgeting process

Capital budgeting chooses which long-term projects to fund. It has four stages: generate ideas, analyze cash flows and test assumptions, plan and approve, then monitor with a post-audit.

Five principles guide every decision at Level 1. Decisions rest on cash flows, not accounting profit. Cash flows are measured after-tax, and only incremental cash flows count. Sunk costs are ignored. Opportunity costs are included. Financing costs are left out, because the discount rate already reflects the cost of funding. Projects are independent when accepting one does not block another, and mutually exclusive when only one can be chosen.

NPV, IRR and payback in CFA corporate issuers

Net present value, or NPV, is the first decision rule and the one the curriculum favors. NPV answers one question: after discounting every future inflow back to today at the required return, is anything left once the upfront cost is paid? If yes, the project adds value. Accept when NPV is positive, reject when it is negative, and for mutually exclusive projects choose the highest NPV.

The internal rate of return, or IRR, is the discount rate that makes NPV equal zero. Accept when IRR exceeds the required return. Yet it has two flaws. It can give more than one answer when cash flows change sign more than once, and it can misrank mutually exclusive projects that differ in size or timing. When NPV and IRR disagree, NPV wins.

Payback and discounted payback ask how fast a project returns its cost. Payback counts the years until cumulative undiscounted inflows cover the investment. Discounted payback does the same with discounted flows. Both check liquidity risk, but neither is a full decision rule, because both ignore cash flows after the cutoff. The profitability index, or PI, equals the present value of future cash flows divided by the initial investment. Accept when PI exceeds 1.0, and use it to rank projects when capital is rationed.

Worked example: NPV, IRR, payback and profitability index

Suppose a project costs $420,000 today and returns $110,000 in year one, $140,000 in year two, $160,000 in year three, $150,000 in year four and $90,000 in year five. The required return is 10 percent. Discount each inflow: year one $100,000, year two $115,702, year three $120,210, year four $102,452 and year five $55,883, for a total present value of $494,247. NPV is $494,247 minus $420,000, or $74,247. The project adds value, so accept.

Next, find the IRR. At 16.5 percent the present value of the inflows is $422,132, so NPV is $2,132. Raising the rate to 17 percent cuts the present value to $417,286, so NPV is -$2,714. NPV falls $4,846 over that 0.5 point rise, so the remaining $2,132 needs about 0.22 points more, giving an IRR of about 16.72 percent. That exceeds the 10 percent required return, so IRR says accept.

Payback counts undiscounted flows: $110,000 plus $140,000 plus $160,000 is $410,000 after three years, leaving $10,000 to recover. Year four brings $150,000, so the project needs $10,000 divided by $150,000, or 0.07 of year four. Payback is therefore 3.07 years. Discounted payback uses discounted flows: $100,000 plus $115,702 plus $120,210 is $335,912 after three years, leaving $84,088 to recover. Year four brings $102,452 discounted, so the project needs $84,088 divided by $102,452, or 0.82 of year four. Discounted payback is therefore 3.82 years. Finally, the profitability index is $494,247 divided by $420,000, or 1.18. When they conflict, trust NPV.

Working capital and the cash conversion cycle in CFA corporate issuers

Working capital funds the daily cycle of buying, selling and collecting cash. Net working capital equals current assets minus current liabilities, and it measures the cushion held to meet short-term bills. A negative cushion is workable when a business collects cash fast and pays suppliers slowly, but it leaves little room for surprise.

The cash conversion cycle, or CCC, measures how many days cash stays tied up in operations. Days inventory outstanding (DIO) counts the days inventory sits before sale. DSO counts the days customers take to pay. DPO counts the days the company takes to pay suppliers. The cycle equals DIO plus DSO minus DPO.

Holding more stock cuts stockouts but ties up cash. Loose credit can lift sales but slows collection and raises bad debt risk. Paying suppliers early can earn discounts but drains cash; paying late preserves cash yet strains relationships. Anything that shortens DIO or DSO, or lengthens DPO, shortens the cycle and frees cash.

Worked example: the cash conversion cycle

Suppose cost of goods sold is $4,380,000 and average inventory $624,000. Days inventory outstanding is $624,000 divided by $4,380,000 times 365, or 52 days. Annual sales are $5,475,000, average receivables $570,000, so days sales outstanding is $570,000 divided by $5,475,000 times 365, giving 38 days. Average payables are $564,000, so days payable outstanding, also on cost of goods sold, is $564,000 divided by $4,380,000 times 365, or 47 days. The cash conversion cycle is 52 plus 38 minus 47, or 43 days.

If current assets are $1,200,000 and current liabilities are $800,000, net working capital is $1,200,000 minus $800,000, or $400,000.

Sources of liquidity, capital structure and governance

Liquidity is the ability to meet short-term bills. Primary sources cover daily cash management: cash, short-term investments, operating cash flow, and stretching payables. Secondary sources are the backup lines for stress: bank lines, commercial paper, asset sales, and new debt or equity.

Capital structure is the mix of debt and equity funding the company. Debt is cheaper than equity because lenders rank ahead of shareholders and interest is tax-deductible, but too much debt raises distress risk. The trade-off theory says the best mix balances the tax benefit of debt against possible bankruptcy costs. Pecking order theory says managers prefer retained earnings first, then debt, and only last new equity. Modigliani and Miller provide the Level 1 baseline: with no taxes and no distress costs, the mix does not change firm value.

On governance, shareholders vote on directors and major changes, and effective boards keep independent directors in the majority with the chair separate from the chief executive.

Exam traps that these CFA corporate issuers notes warn you about

• NPV beats IRR when they disagree. IRR can misrank mutually exclusive projects and give multiple answers, so NPV decides.
• Sunk costs stay out, opportunity costs stay in. Money already spent is gone; an asset’s next best use is a real project cost.
• Payback ignores what happens after the cutoff. A project can pay back fast and still destroy value. Never accept on payback alone.
• Financing costs do not enter project cash flows. Interest belongs in the discount rate; counting it there double counts it.
• A longer DPO shortens the cycle, but it is not free money. Late payment frees cash now and can cost discounts and goodwill later.

One-page revision box: CFA corporate issuers notes

• Weight: 6 to 9 percent of the 2026 Level 1 exam, about 11 to 16 of 180 questions. From February 2027 the topic is renamed Corporate Finance, with the same weight.
• Capital budgeting uses after-tax incremental cash flows: ignore sunk costs, include opportunity costs, exclude financing costs. Independent projects do not block each other; only one mutually exclusive project can be chosen.
• NPV = present value of inflows minus cost; accept when positive. IRR = rate where NPV is zero; accept above the required return. NPV decides.
• Payback = years to recover cost; discounted payback uses discounted flows. PI = present value of inflows divided by cost; accept above 1.0.
• Worked 1: $420,000 cost, uneven inflows of $110,000, $140,000, $160,000, $150,000 and $90,000 over five years at 10 percent. NPV $74,247, IRR 16.72 percent, payback 3.07 years, discounted payback 3.82 years, PI 1.18.
• CCC = DIO plus DSO minus DPO. NWC = current assets minus current liabilities. Worked 2: DIO 52, DSO 38, DPO 47, a 43-day cycle, NWC $400,000.
• Liquidity: primary sources are cash, short-term investments, operating cash flow and stretching payables; secondary are bank lines, commercial paper, asset sales and new debt or equity.
• Capital structure: trade-off theory balances tax benefits against distress costs; pecking order is retained earnings, then debt, then new equity. Governance: independent directors in the majority, chair separate from chief executive.
• Modigliani and Miller: with no taxes and no distress costs, the mix does not change firm value.

Work each example above once with the numbers changed. Then test yourself against our CFA derivatives notes before returning to the CFA notes hub for your next topic.