A segment creates value, not just revenue
Sales share and contribution to value are different. A division with high revenue may require expensive equipment renewal and working capital; a small one may generate more incremental cash flow per newly invested resource. Start with incremental flows, not accounting turnover. Low current profitability does not explain the cause either: a new launch, temporary utilization, persistent competitive pressure or mistaken expansion may be involved.
Project NPV is the present value of all incremental cash flows, including the initial investment. If the value has already been calculated, do not subtract the initial expenditure again. Positive NPV under selected assumptions does not automatically make a project feasible: it still needs money at the required time, a management team and no conflict with other projects. A segment’s past high return does not guarantee the same marginal return on a new investment.
Three indivisible projects and a budget of ten
All amounts are in millions of notional units. Project A requires 6 now and has NPV 2.4; B requires 5 and has NPV 2; C requires 5 and has NPV 1.9. The current-period budget is 10. Projects are independent, their NPVs add, fractional execution is prohibited and there are no future constraints in this first model. Capital expenditure is already included in each project’s NPV.
Each project passes on its own. A and B together require 11, and A and C also require 11; both sets are infeasible. B and C require exactly 10 and give NPV 3.9, more than any single project. A leaves 4 unused units, but they cannot purchase part of B or C. Therefore B + C is optimal in the stated model. This follows from comparing every feasible combination, not from judging managers.
Why a simple ranking can fail
If projects are ranked only by NPV divided by initial expenditure, A and B both have 0.4 while C has 0.38. Breaking the tie in favor of A leaves 2.4 instead of 3.9. With indivisible projects, a simple ranking does not guarantee the best set. A problem with divisible independent investments could be different, but fractional execution must be declared rather than silently changed after a poor selection.
Money is not the only constraint
Let each project choice x be zero or one. The mathematical problem is to maximize 2.4xA + 2xB + 1.9xC subject to 6xA + 5xB + 5xC ≤ 10. If B and C simultaneously need the same indivisible launch team, add xB + xC ≤ 1. The previous winner is then excluded and, under the other stated conditions, A with NPV 2.4 remains. The people constraint changed the decision even though the cash budget stayed the same.
For the second year, introduce a separate cost line and a separate available budget. Free cash today cannot automatically pay every future need without conditions concerning storage, financing and timing. Shared technology, cannibalization of sales and mandatory project sequencing break simple additivity; in that case, evaluate joint incremental cash flows rather than adding standalone NPVs.
In a real company, management capacity cannot always be measured precisely in units. At least identify the scarce skill, duration of commitment and possible conflict. Assigning a strong team to a division with low current profit can sometimes be justified by a large incremental effect, and sometimes reflect only a habit of rescuing an old line. A single current profitability number cannot distinguish the two.
Check the decision before approving the budget
Check why segments differ, whether forecasts are comparable, the cost of capital, the possible duration of competitive advantage and expectations already embedded in the initial valuations. Then change key assumptions: launch delay, investment amount and additional demand. If C’s NPV falls from 1.9 to 0.3, B + C gives 2.3 and loses to A at 2.4. Choice stability matters more than a beautifully precise ranking from one table.
The exercise does not prove that the market misprices segments and does not recommend shares of a company with a particular budget. It demonstrates the testable difference between the attractiveness of one project and the feasibility of a set under constraints. No artistic analogy is needed: the objective, cash flows, constraints and alternatives are explicit.