Practice test 7 for Financial Management and Strategic Management covering Cost of Capital, Investment Decisions - Capital Budgeting, Strategic Analysis: External Environment, Strategic Analysis: Internal Environment.
16 questions across 4 chapters, 30 marks and 60 minutes in the timed paper. Every answer below is shown with the working behind it and the authority it rests on.
Law and standards used: ICAI Study Material for CA Intermediate Paper 6: Financial Management and Strategic Management (relevant for January 2027 attempt).
Questions
16
Marks
30
Time limit
60 minutes
Attempt
January 2027
Group
Group 2
Law basis
ICAI Study Material for CA Intermediate Paper 6: Financial Management and Strategic Management (relevant for January 2027 attempt)
Content as of
2026-11-04
Chapters covered
Cost of Capital (5 Q)
Investment Decisions - Capital Budgeting (3 Q)
Strategic Analysis: External Environment (5 Q)
Strategic Analysis: Internal Environment (3 Q)
Questions, answers and explanations
Question 1 · 2 marks · Cost of Capital · medium
Scenario. Radiant Solar Ltd follows a target capital structure of debt 40 percent, preference capital 10 percent and equity 50 percent. It has retained earnings of ₹24 lakh available for the current financing programme. The after-tax cost of debt is 6.0 percent, the cost of preference capital is 11.0 percent, the cost of retained earnings is 13.5 percent and the cost of fresh equity after flotation expenses is 15.5 percent. The company is evaluating the weighted marginal cost of capital at different financing levels.
What is the break-point in the total financing schedule at which Radiant Solar Ltd exhausts its retained earnings of ₹24 lakh, given the 50 percent equity weight?
Explanation. The break-point is the total financing amount that can be raised before the equity component changes from retained earnings to fresh equity. It equals retained earnings divided by the equity weight. ₹24 lakh divided by 0.50 gives ₹48 lakh. Therefore option b is correct. Options a, c and d incorrectly divide by other weights or use an incorrect financing total.
Where it goes wrong. Students may divide retained earnings by the debt or preference weight instead of the equity weight.
Authority. Chapter 4: Cost of Capital - Weighted Average Cost of Capital and Marginal Cost of Capital
Question 2 · 2 marks · Cost of Capital · medium
What is the weighted marginal cost of capital for the first ₹48 lakh of financing, using retained earnings as the equity component?
Explanation. The weighted marginal cost for the first ₹48 lakh uses 40 percent debt at 6 percent, 10 percent preference at 11 percent and 50 percent retained earnings at 13.5 percent. The weighted total is 10.25 percent. Option d is correct. Options a, b and c arise from arithmetic errors or from using fresh equity cost before the break-point.
Where it goes wrong. Using the fresh equity cost of 15.5 percent before the retained earnings break-point overstates the initial marginal cost.
Authority. Chapter 4: Cost of Capital - Weighted Average Cost of Capital and Marginal Cost of Capital
Question 3 · 2 marks · Cost of Capital · medium
What is the weighted marginal cost of capital for financing beyond ₹48 lakh, assuming the debt and preference costs remain unchanged and fresh equity cost is 15.5 percent?
Explanation. After the break-point, the equity weight is financed by fresh equity at 15.5 percent. The weighted marginal cost is 0.40 × 6.0 plus 0.10 × 11.0 plus 0.50 × 15.5, which equals 11.25 percent. Option a is correct. Options b, c and d result from using retained earnings cost or from calculation errors.
Where it goes wrong. Continuing to use retained earnings cost after the break-point ignores the flotation cost of fresh equity.
Authority. Chapter 4: Cost of Capital - Weighted Average Cost of Capital and Marginal Cost of Capital
Question 4 · 2 marks · Investment Decisions - Capital Budgeting · medium
Scenario. Shivalik Heavy Engineering is evaluating replacement of a five-year-old machine. The old machine cost ₹20,00,000 and is depreciated on a straight-line basis over ten years to zero book value. It can be sold today for ₹8,00,000. The new machine costs ₹30,00,000, has a five-year life, a salvage value of ₹2,00,000 and is depreciated on a straight-line basis to its salvage value. The new machine is expected to increase annual contribution by ₹8,00,000 and reduce annual cash operating costs by ₹3,00,000. The tax rate is 30 percent and the cost of capital is 12 percent. PVAF at 12 percent for five years is 3.605 and PVIF at 12 percent for five years is 0.567.
What is the tax effect of selling the old machine today for ₹8,00,000 when its book value is ₹10,00,000 and the tax rate is 30 percent?
Tax payable of ₹60,000
No tax effect
Tax shield of ₹60,000 (correct answer)
Tax shield of ₹2,00,000
Answer: C — Tax shield of ₹60,000
Working. Book value = ₹20,00,000 − five years × ₹2,00,000 = ₹10,00,000. Loss = ₹10,00,000 − ₹8,00,000 = ₹2,00,000. Tax shield = ₹2,00,000 × 30 percent = ₹60,000.
Explanation. The old machine has a book value of ₹10,00,000 and is sold for ₹8,00,000. The loss on sale is ₹2,00,000. At a 30 percent tax rate, the loss saves tax of ₹60,000. This is a tax shield and is treated as a cash inflow in the initial outlay. Option c is correct. Option a treats the shield as tax payable, option b ignores the loss and option d wrongly applies the tax rate to the full loss amount without using 30 percent.
Where it goes wrong. Applying the tax rate to the sale value instead of the loss on sale gives an incorrect tax effect.
Authority. Chapter 7: Investment Decisions - Estimation of Project Cash Flows and Replacement Decisions
Question 5 · 2 marks · Investment Decisions - Capital Budgeting · hard
What is the incremental annual operating cash flow after tax from replacing the old machine with the new machine?
Explanation. Incremental earnings before depreciation and tax are ₹11,00,000. Incremental depreciation is new depreciation of ₹5,60,000 less old depreciation of ₹2,00,000, which equals ₹3,60,000. Incremental profit before tax is ₹7,40,000. Tax at 30 percent is ₹2,22,000. Profit after tax is ₹5,18,000. Adding back incremental depreciation of ₹3,60,000 gives ₹8,78,000. Option d is correct. Options a, b and c arise from incorrect depreciation or tax adjustments.
Where it goes wrong. Using only the new machine depreciation and ignoring the old machine depreciation overstates the incremental tax shield.
Authority. Chapter 7: Investment Decisions - Estimation of Project Cash Flows and Replacement Decisions
Question 6 · 2 marks · Investment Decisions - Capital Budgeting · hard
What is the net present value of the replacement decision?
Explanation. The initial outlay is the new machine cost of ₹30,00,000 less the old machine sale proceeds of ₹8,00,000 and the tax shield of ₹60,000, giving ₹21,40,000. The present value of annual operating cash flows is ₹8,78,000 × 3.605, which is ₹31,65,190. The present value of salvage is ₹2,00,000 × 0.567, which is ₹1,13,400. Total present value is ₹32,78,590. NPV is ₹32,78,590 − ₹21,40,000 = ₹11,38,590, approximately ₹11.39 lakh. Option a is correct. Options b, c and d arise from omitting the tax shield, using incorrect depreciation or ignoring salvage.
Where it goes wrong. Omitting the tax shield on the loss on sale of the old machine understates the initial outlay and gives an incorrect NPV.
Authority. Chapter 7: Investment Decisions - Estimation of Project Cash Flows and Replacement Decisions
Question 7 · 2 marks · Cost of Capital · hard
Scenario. Radiant Power Ltd issued 10,000 9 percent redeemable preference shares of face value ₹100 each at ₹95 per share. Flotation expenses are 2 percent of the issue price. The shares are redeemable after five years at ₹105 per share. The company is examining the cost of preference capital and the tax treatment of preference dividend under the current Indian tax framework.
What is the approximate cost of redeemable preference capital using the approximation method?
10.85 percent
11.49 percent (correct answer)
12.10 percent
13.05 percent
Answer: B — 11.49 percent
Working. NP = ₹95 − 2 percent of ₹95 = ₹93.10. Kp = [₹9 + (₹105 − ₹93.10) divided by 5] divided by [(₹105 + ₹93.10) divided by 2] = ₹11.38 divided by ₹99.05 = 11.49 percent.
Explanation. Net proceeds are issue price ₹95 less flotation of 2 percent of issue price, which is ₹1.90, giving ₹93.10. Annual preference dividend is ₹9. Redemption value is ₹105. Using the approximation formula, the numerator is ₹9 plus ₹11.90 divided by 5, which equals ₹11.38. The denominator is the average of ₹105 and ₹93.10, which is ₹99.05. The cost is 11.38 divided by 99.05, which is 11.49 percent. Option b is correct. Options a, c and d arise from using issue price, face value or redemption value incorrectly.
Where it goes wrong. Using the face value ₹100 instead of net proceeds ₹93.10 as the denominator base overstates or understates the cost.
Authority. Chapter 4: Cost of Capital - Cost of Preference Share Capital
Question 8 · 1 marks · Cost of Capital · medium
Which statement is correct for the cost of preference capital under the current Indian tax framework?
Preference dividend is tax deductible and reduces cost by the tax rate
Dividend distribution tax is added to the cost of preference capital
Preference dividend is not tax deductible and current Indian tax law does not levy dividend distribution tax at the company level (correct answer)
Dividend distribution tax is deductible in computing the cost of preference capital
Answer: C — Preference dividend is not tax deductible and current Indian tax law does not levy dividend distribution tax at the company level
Working. No tax adjustment is made to preference dividend for the cost of preference capital. Taxability, if any, arises in the hands of the recipient under the applicable regime.
Explanation. Preference dividend is an appropriation of profit and is not allowed as a tax-deductible expense. Under the current Indian tax framework, dividend distribution tax is not levied at the company level. Therefore the cost of preference capital is not adjusted for tax in the manner of debt. Option c is correct. Options a, b and d incorrectly assume tax deductibility or levy of dividend distribution tax at the company level.
Where it goes wrong. Applying the debt tax shield to preference dividend is a conceptual error because preference dividend is not tax deductible.
Authority. Chapter 4: Cost of Capital - Cost of Preference Share Capital
Question 9 · 2 marks · Strategic Analysis: External Environment · medium
Scenario. StreamLine OTT operates in the streaming entertainment industry. Ready-made content is available for licensing, viewers can switch apps easily and many platforms chase the same subscribers with similar releases and heavy advertising. Exclusive sports rights and local-language originals require large sunk content spending, but cloud distribution is accessible to new platforms.
Which condition most appropriately raises the threat of new entrants for StreamLine OTT?
Exclusive sports rights held by existing platforms
Large sunk content spending by incumbents
Strong brand loyalty of existing platforms
Ready-made content licensing and low viewer switching costs (correct answer)
Answer: D — Ready-made content licensing and low viewer switching costs
Working. Threat of entry is higher when capital requirements, product differentiation, switching costs and access to distribution are low. Ready-made licensing and low switching costs reduce entry barriers.
Explanation. The threat of new entrants increases when entry barriers are low. Ready-made content licensing reduces the need for original content creation, and low viewer switching costs make it easier for a new platform to attract subscribers. Therefore option d is correct. Options a, b and c are entry barriers that reduce the threat of new entrants.
Where it goes wrong. Students may treat exclusive rights and brand loyalty as factors that increase entry threat, whereas they actually raise entry barriers.
Authority. Chapter 2: Strategic Analysis - External Environment - Porter Five Forces Model
Question 10 · 2 marks · Strategic Analysis: External Environment · medium
Which factor most appropriately increases buyer bargaining power in the OTT industry?
Exclusive bundled telecom and OTT packages
Easy switching among apps and low differentiation in monthly subscription offers (correct answer)
High fixed content costs incurred by platforms
Regulatory licensing requirements for platforms
Answer: B — Easy switching among apps and low differentiation in monthly subscription offers
Working. Buyer power is higher when switching costs are low, products are standardised, buyers are price sensitive and buyers can compare alternatives easily.
Explanation. Buyer power increases when buyers can switch easily, compare prices and perceive little differentiation. Easy switching among apps and low differentiation in subscription offers increase buyer bargaining power. Option b is correct. Exclusive bundles reduce buyer power, high fixed content costs affect rivalry and cost structure, and licensing requirements affect entry rather than buyer power directly.
Where it goes wrong. Confusing supplier or entry barriers with buyer power can lead to selecting a cost or regulatory factor.
Authority. Chapter 2: Strategic Analysis - External Environment - Porter Five Forces Model
Question 11 · 2 marks · Strategic Analysis: External Environment · medium
Which condition most appropriately increases competitive rivalry among OTT platforms?
Many platforms pursuing the same subscribers with similar releases and heavy advertising (correct answer)
Only one platform with exclusive rights to all content
A single dominant supplier of content
Absence of substitutes for streaming entertainment
Answer: A — Many platforms pursuing the same subscribers with similar releases and heavy advertising
Working. Rivalry among existing firms increases with many competitors, slow growth, high fixed costs, low differentiation and high strategic stakes.
Explanation. Rivalry is intense when many competitors pursue the same buyers with similar offerings and high advertising or content spending. Option a is correct. Option b reduces rivalry, option c relates to supplier power and option d reduces substitute pressure rather than directly increasing rivalry among existing platforms.
Where it goes wrong. Selecting substitute pressure or supplier power when the question asks specifically about rivalry among existing firms.
Authority. Chapter 2: Strategic Analysis - External Environment - Porter Five Forces Model
Question 12 · 2 marks · Strategic Analysis: Internal Environment · medium
Scenario. Vayu Drone Tech has developed flight-control algorithms, battery-management know-how and systems-integration skills. Its competences allow it to serve surveillance, agricultural spraying and mapping drone markets. Customers pay a premium for longer flight time and lower downtime. Some algorithms are patented and the integration know-how is tacit and difficult to replicate.
Which feature of Vayu Drone Tech most appropriately satisfies the market access test of a core competence under the Prahalad-Hamel framework?
Customers value longer flight time and lower downtime
Competitors find the tacit integration know-how difficult to copy
The competence enables participation in surveillance, agricultural spraying and mapping drone markets (correct answer)
The company uses low-cost components
Answer: C — The competence enables participation in surveillance, agricultural spraying and mapping drone markets
Working. Prahalad-Hamel core competency tests include market access, customer-perceived value and competitor imitability. The multiple market applications satisfy market access.
Explanation. The market access test asks whether a competence opens access to a wide variety of markets. Vayu Drone Tech uses its competence across surveillance, agricultural spraying and mapping markets, so option c is correct. Option a relates to customer-perceived value, option b relates to competitor imitability and option d is a cost attribute rather than the market access test.
Where it goes wrong. Confusing customer value or imitability with the market access test of core competence.
Question 13 · 2 marks · Strategic Analysis: Internal Environment · medium
Which feature of Vayu Drone Tech most appropriately satisfies the customer-perceived value test of a core competence?
The competence opens multiple product markets
Customers pay a premium for longer flight time and lower downtime (correct answer)
Patents and tacit know-how make imitation difficult
The company uses low-cost components
Answer: B — Customers pay a premium for longer flight time and lower downtime
Working. Customer-perceived value requires that the competence contribute to a benefit that influences the customer purchase decision and supports premium or loyalty.
Explanation. The customer-perceived value test asks whether the competence delivers a fundamental benefit that customers value and for which they are willing to pay. A premium for longer flight time and lower downtime satisfies this test. Option b is correct. Option a is market access, option c is imitability and option d is a cost input rather than customer-perceived value.
Where it goes wrong. Treating low-cost inputs as customer value without linking the competence to a benefit perceived by customers.
Question 14 · 2 marks · Strategic Analysis: Internal Environment · medium
Which feature of Vayu Drone Tech most appropriately satisfies the competitor imitability test of a core competence?
The competence opens access to multiple markets
Customers pay a premium for the product
The company uses inexpensive labour
Patented flight-control algorithms and tacit integration know-how are difficult to replicate (correct answer)
Answer: D — Patented flight-control algorithms and tacit integration know-how are difficult to replicate
Working. A competence satisfies the imitability test when it is protected by patents, tacit knowledge, complexity, path dependence or other isolating mechanisms.
Explanation. The imitability test asks whether competitors can readily replicate the competence. Patented algorithms and tacit integration know-how are difficult to replicate, so option d is correct. Option a is market access, option b is customer-perceived value and option c is a general cost factor rather than a source of hard-to-imitate competence.
Where it goes wrong. Selecting customer value or multiple market access when the question specifically asks about competitor imitability.
Question 15 · 2 marks · Strategic Analysis: External Environment · medium
Scenario. PrintMedia Ltd operates in the print and publishing industry. The market has slowed, competition is tough, prices are stable and cash generation is important. Some product lines are now facing a sharp decline because digital substitutes are replacing print products. The management is considering strategic choices for the maturity and decline phases of the industry life cycle.
In the maturity phase of the industry life cycle, which strategic emphasis is most appropriate for PrintMedia Ltd?
Maintain stability, defend market share and focus on cost efficiency and cash generation (correct answer)
Expand capacity aggressively for rapid market growth
Diversify immediately without assessing cash flows
Exit the industry immediately in all product lines
Answer: A — Maintain stability, defend market share and focus on cost efficiency and cash generation
Working. Maturity phase characteristics include slow growth, intense competition, stable market and pressure on profits. Strategic emphasis shifts to stability, efficiency and cash generation.
Explanation. In maturity, sales growth slows, competition is tough and the market stabilises. The appropriate emphasis is on maintaining stability, defending share, improving cost efficiency and generating cash. Option a is correct. Aggressive capacity expansion suits growth, immediate diversification without cash assessment is imprudent and immediate exit is not appropriate for all product lines in maturity.
Where it goes wrong. Applying growth-phase expansion strategies during maturity can lead to overcapacity and weak cash flows.
Question 16 · 1 marks · Strategic Analysis: External Environment · medium
Which strategic response is most appropriate for a product line of PrintMedia Ltd that has entered the decline phase because of digital substitution?
Expand production capacity aggressively
Increase prices without any differentiation
Use selective harvesting or retrenchment and consider diversification if cash flows permit (correct answer)
Invest heavily in research and development for the old print product without reviewing demand
Answer: C — Use selective harvesting or retrenchment and consider diversification if cash flows permit
Working. Decline phase responses include divestment, retrenchment, selective harvesting and diversification. The choice depends on cash generation, competitive position and alternative opportunities.
Explanation. In decline, sales and profits fall because of substitutes or changing demand. Appropriate responses include selective harvesting, retrenchment or diversification when cash flows and capabilities permit. Option c is correct. Capacity expansion, undifferentiated price increases and heavy research spending on an obsolete product without demand review are generally inappropriate.
Where it goes wrong. Continuing to invest heavily in a declining product line ignores the strategic implication of substitute products and declining demand.
Chapter 4: Cost of Capital - Weighted Average Cost of Capital and Marginal Cost of Capital · Chapter 7: Investment Decisions - Estimation of Project Cash Flows and Replacement Decisions · Chapter 4: Cost of Capital - Cost of Preference Share Capital · Chapter 2: Strategic Analysis - External Environment - Porter Five Forces Model · Chapter 3: Strategic Analysis - Internal Environment - Core Competency · Chapter 2: Strategic Analysis - External Environment - Product Life Cycle
Questions people ask
What does Test 7 cover?
Comprehensive exam-standard case scenarios and MCQs on Cost of Capital, Investment Decisions - Capital Budgeting, Strategic Analysis: External Environment, Strategic Analysis: Internal Environment across Financial Management (Section A) and Strategic Management (Section B).
How is Test 7 scored?
16 questions across 6 case scenarios carrying 30 marks (14 questions at 2 marks each, and 2 questions at 1 mark each) in 60 minutes with no negative marking.
