Forecasting Capital Investments and Capital Structure

Updated for the 2026-2027 CFA® Level I curriculum.

Forecasting a company's capital investments means projecting how much it will spend on long-term assets like property, plant, and equipment. Forecasting capital structure means projecting how that spending gets funded, through debt, equity, or internal cash flow. These two forecasts are connected.

After reviewing this note, you should be able to build both forecasts and check that they stay consistent with the rest of the model.

Key Takeaways About Forecasting Capital Investments and Capital Structure

• Capital expenditure forecasts start with a revenue or asset-based driver, not a guess.

• Common capex approaches include percent-of-sales, fixed asset turnover targets, and management guidance.

• Capital structure forecasts determine how new investment gets funded once capex is projected.

• A funding gap exists when forecast capex exceeds forecast cash flow from operations.

• Target capital structure or stated financial policy usually sets the debt-equity split used to fill that gap.

• Every forecast assumption should connect to at least one other line item.

• Analysts revisit capex and financing forecasts together, not as separate exercises.

What You Need to Know for CFA Level I

• Identify the main approaches used to forecast capital expenditures.

• Explain how financing needs are forecast once capex is projected.

• Determine how a funding gap affects assumptions about debt and equity issuance.

• Apply consistency checks across capex, financing, and other forecast line items.

• Recognize when changing one assumption requires updating others in the forecast.

Approaches to Forecasting Capital Expenditures and Investments

Analysts use a few standard approaches to project capex. Each ties the forecast to a specific driver instead of an isolated number.

Percent of sales

Capex is forecast as a percentage of revenue, based on the company's historical average or a recent trend. This works well for companies with stable, ongoing capital needs.

Fixed asset turnover target

The analyst sets a target ratio of revenue to average net fixed assets. Dividing forecast revenue by that ratio gives the required fixed asset base. The difference between the required base and the current base, plus expected depreciation, gives the capex forecast.

Management guidance

Many companies disclose planned capex in earnings calls or investor presentations. Analysts often start with this guidance and adjust it based on their own judgment about execution risk or timing.

Capacity-driven forecasts

If a company is capacity-constrained, capex is tied directly to planned unit growth or capacity expansion, such as a new plant or store openings.

None of these approaches is universally correct. The right choice depends on the company's industry, disclosure quality, and growth stage.

Approaches to Forecasting Financing and Capital Structure

Once capex is forecast, the next step is deciding how it gets funded. This depends on the relationship between capex and cash flow from operations (CFO).

If forecast CFO exceeds forecast capex, the company has surplus cash. That surplus can reduce debt, fund buybacks, or increase dividends. No new external financing is required.

If forecast capex exceeds forecast CFO, a funding gap exists. The company must close that gap with new debt, new equity, or a combination of both. Analysts typically use one of these approaches to forecast the mix:

• Maintain current capital structure. The financing mix for new investment matches the company's existing debt-to-equity ratio.

• Move toward a target capital structure. The company is assumed to shift its financing mix over time toward a stated target ratio.

• Follow stated financial policy. Management guidance on leverage limits, payout policy, or buyback plans sets the financing assumption directly.

The approach chosen should match how the company has actually behaved or what management has communicated. Inventing a financing mix with no support weakens the forecast.

How Investment Needs Can Affect Funding Assumptions

The size of the funding gap has direct effects on other forecast assumptions. A large capex program that is funded mostly with debt raises leverage ratios. Higher leverage increases forecast interest expense, which reduces forecast net income and, in turn, forecast earnings per share.

Debt vs Equity Funding

Funding the gap with equity instead avoids that leverage increase, but it raises the share count. A higher share count dilutes earnings per share even if net income is unaffected.

Analysts should also check whether the assumed financing mix is realistic. A company near its leverage covenant limits, or with a weak credit rating, may not be able to add much new debt, regardless of what a simple ratio-based assumption suggests.

How to Maintain Consistency Across the Forecast

A forecast is a connected system, not a set of independent line items. Changing one assumption without updating related items breaks that system.

Trace Changes Through the Financial Statements

Consider a capex increase driven by a higher fixed asset turnover target. That increase raises net fixed assets on the balance sheet. Higher fixed assets increase future depreciation expense, which lowers operating income and net income.

If the capex increase also creates a larger funding gap, forecast debt or equity issuance must rise as well. New debt raises interest expense, which lowers net income further and reduces retained earnings on the balance sheet.

Before finalizing a forecast, confirm three things: the balance sheet still balances, the cash flow statement ties to the balance sheet and income statement, and the financing assumption matches the company's stated policy or target structure.

Forecast Driver Framework

Worked Example

XYZ Company reports current revenue of $500 million and current net fixed assets of $200 million. The analyst forecasts three things for next year:

1. Revenue growth of 8%, to $540 million.

2. A target fixed asset turnover ratio of (revenue divided by average net fixed assets).

3. Depreciation expense equal to 10% of beginning net fixed assets.

Step 1: Find required net fixed assets

Step 2: Find the increase in net fixed assets

Step 3: Find depreciation expense

Step 4: Find forecast capex

Capex = Increase in net fixed assets + Depreciation = $16 million + $20 million = $36 million

Step 5: Compare capex to forecast CFO

Step 6: Apply the financing policy

If XYZ's stated policy is 30% debt and 70% equity for new financing, the gap is filled with $2.4 million in new debt and $5.6 million in new equity or retained earnings.

The capex forecast comes directly from the asset turnover target, not a guess. Because CFO does not fully cover capex, XYZ needs external financing. Applying its stated policy shows most of that gap gets filled with equity, which limits the increase in leverage.

Common Exam Traps

Changing one assumption without updating related items

Raising the capex growth rate without adjusting depreciation, fixed assets, or the financing need produces an inconsistent forecast.

Treating a forecast as certain

A capex or financing forecast is a set of assumptions, not a guaranteed outcome. Exam questions often test whether you recognize this distinction.

Using inconsistent assumptions

Pairing high revenue growth with a static or unrelated financing assumption ignores the link between investment needs and funding.

Confusing a single sensitivity change with a full scenario

A true scenario moves multiple related assumptions together. Changing only one input while holding everything else fixed is a sensitivity test, not a scenario.

Practice Question

An analyst forecasts that a company's capital expenditures will rise from $30 million to $45 million next year due to a plant expansion. Cash flow from operations is forecast to remain at $40 million. The company's stated financial policy is to fund any investment beyond internally generated cash flow with 50% debt and 50% equity.

Based on this policy, how much new debt should the analyst forecast?

1. $2.5 million

2. $5.0 million

3. $22.5 million

FAQs About Forecasting Capital Investments and Capital Structure