Test 1: Financing Decisions - Leverages: answer key
This chapter-wise practice test covers Financing Decisions - Leverages - Test 1 for CA Intermediate Group 2 students preparing for the May 2027 examination attempt. It carries 40 marks across 20 questions in case scenarios and standalone practical MCQs with a time limit of 45 minutes and no negative marking.
20 questions across 1 chapter, 40 marks and 45 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 2027 attempt).
Questions
20
Marks
40
Time limit
45 minutes
Attempt
May 2027
Group
Group 2
Law basis
ICAI Study Material for CA Intermediate Paper 6: Financial Management and Strategic Management (relevant for 2027 attempt)
Content as of
2026-11-10
Chapters covered
Financing Decisions - Leverages (20 Q)
Questions, answers and explanations
Question 1 · 2 marks · Financing Decisions - Leverages · medium
Scenario. Bharat Renewables Ltd (BRL) manufactures solar inverters and energy-storage systems. The CFO is preparing the FY 2026-27 operating and financing plan. BRL has a simple capital structure with only equity shares and a term loan. The following data have been finalized:
| Particulars | Amount/Rate |
|---|---|
| Sales | ₹1,00,00,000 |
| Variable cost | 60% of sales |
| Fixed operating cost | ₹20,00,000 |
| 10% term loan | ₹50,00,000 |
| Equity shares of ₹10 each | 5,00,000 shares |
| Corporate tax rate | 25% |
There are no preference shares and no other borrowings. The company is currently operating above its break-even level. The management is examining the effect of a 15% increase in sales on earnings per share, assuming selling price and cost structure remain unchanged. Separately, the production team has proposed an automation plan that would increase fixed operating cost by ₹5,00,000 but reduce variable cost by ₹5,00,000 at the current sales level. The CFO wants to assess operating leverage, financial leverage, break-even sales, margin of safety and the sensitivity of EPS before approving the proposal. All sales are cash sales and there is no interest income. The company follows a constant tax rate and has no deferred tax adjustments. The CFO has asked for calculations based on the existing data and the proposed automation plan. The company wants to understand whether higher fixed costs can increase business risk even when current EBIT remains unchanged.
For Bharat Renewables Ltd, what is the Degree of Operating Leverage (DOL) at the current sales level?
2.00 times (correct answer)
1.67 times
2.50 times
1.80 times
Answer: A — 2.00 times
Explanation. Contribution = Sales − Variable cost = ₹1,00,00,000 − ₹60,00,000 = ₹40,00,000. EBIT = Contribution − Fixed operating cost = ₹40,00,000 − ₹20,00,000 = ₹20,00,000. DOL = Contribution / EBIT = ₹40,00,000 / ₹20,00,000 = 2.00 times. Option b is a trap from dividing contribution by EBT instead of EBIT. Option c uses fixed cost plus interest in the denominator.
Where it goes wrong. Using EBT instead of EBIT in the DOL denominator.
Question 5 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Zenith Power Systems Ltd operates a capital-intensive plant manufacturing industrial voltage stabilizers. The plant has an installed capacity of 2,00,000 units per annum. For the year ending 31 March 2027, the budgeted production and sales are 1,50,000 units. The company sells each unit at ₹100. Variable cost is ₹40 per unit. Fixed operating cost, excluding interest, is ₹45,00,000. The company has funded its operations through equity and a 10% term loan of ₹50,00,000. There are 4,00,000 equity shares of ₹10 each outstanding and the applicable corporate tax rate is 30%. The company has no preference share capital. The CFO is concerned about the plant's high fixed-cost structure and wants to measure operating, financial and combined leverage before negotiating a wage settlement. The union has proposed a revision that would reduce variable cost by ₹10 per unit but increase fixed operating cost by ₹10,00,000 per annum. This change would apply from the current volume of 1,50,000 units. The marketing team expects no change in selling price. The finance team wants to compute the break-even point in units, margin of safety, degree of operating leverage, degree of financial leverage and the revised operating leverage under the union proposal. The CFO also wants to know the impact on EBIT if sales volume falls by 20% from the budgeted level. Assume that the company operates within the relevant range, and all costs behave as stated.
For Zenith Power Systems Ltd, what is the Degree of Financial Leverage (DFL) at the budgeted sales level?
1.00 times
1.125 times (correct answer)
1.20 times
1.33 times
Answer: B — 1.125 times
Explanation. Contribution per unit = ₹100 − ₹40 = ₹60. Total contribution = 1,50,000 × ₹60 = ₹90,00,000. EBIT = ₹90,00,000 − ₹45,00,000 = ₹45,00,000. Interest = ₹50,00,000 × 10% = ₹5,00,000. EBT = ₹45,00,000 − ₹5,00,000 = ₹40,00,000. DFL = EBIT / EBT = ₹45,00,000 / ₹40,00,000 = 1.125 times. Option c uses interest at 12% instead of 10%. Option d computes DOL, not DFL.
Where it goes wrong. Using the wrong interest rate or calculating DOL instead of DFL.
Question 6 · 2 marks · Financing Decisions - Leverages · medium
If Zenith Power Systems Ltd suffers a 20% decline in sales volume from 1,50,000 units, what will be its new EBIT?
₹27,00,000 (correct answer)
₹30,00,000
₹36,00,000
₹40,00,000
Answer: A — ₹27,00,000
Explanation. New volume = 1,50,000 × 80% = 1,20,000 units. Contribution per unit = ₹60. New contribution = 1,20,000 × ₹60 = ₹72,00,000. Fixed operating cost remains ₹45,00,000. New EBIT = ₹72,00,000 − ₹45,00,000 = ₹27,00,000. Alternatively, DOL = 2; a 20% fall in sales reduces EBIT by 40%, so EBIT = ₹45,00,000 × 60% = ₹27,00,000. Option b wrongly applies only a 33.33% decline.
Where it goes wrong. Applying the sales decline directly to EBIT without DOL magnification.
Question 9 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Surya Ltd has contribution of ₹36,00,000, fixed operating cost of ₹18,00,000 and interest on debt of ₹4,00,000. What is its Degree of Combined Leverage (DCL)?
Surya Ltd has contribution of ₹36,00,000, fixed operating cost of ₹18,00,000 and interest on debt of ₹4,00,000. What is its Degree of Combined Leverage (DCL)?
Question 10 · 2 marks · Financing Decisions - Leverages · medium
Scenario. A firm has DOL of 2.4 and DFL of 1.5. If sales increase by 10%, what will be the percentage increase in EPS?
A firm has DOL of 2.4 and DFL of 1.5. If sales increase by 10%, what will be the percentage increase in EPS?
30%
36% (correct answer)
24%
15%
Answer: B — 36%
Explanation. DCL = DOL × DFL = 2.4 × 1.5 = 3.6. DCL measures the percentage change in EPS for a given percentage change in sales. Percentage increase in EPS = DCL × percentage increase in sales = 3.6 × 10% = 36%. Option a (30%) is a distractor arising from miscalculating the combined leverage effect.4 and 1.5 incorrectly; option c uses only DOL and gives 24%.
Where it goes wrong. Multiplying only by DOL or adding DOL and DFL.
Question 12 · 2 marks · Financing Decisions - Leverages · medium
Scenario. If the margin of safety of a firm is 25%, what is its Degree of Operating Leverage (DOL)?
If the margin of safety of a firm is 25%, what is its Degree of Operating Leverage (DOL)?
0.25 times
1.25 times
2.50 times
4.00 times (correct answer)
Answer: D — 4.00 times
Explanation. DOL = 1 / Margin of safety, when margin of safety is expressed as a proportion of sales. MOS = 25% = 0.25. DOL = 1 / 0.25 = 4.00 times. Option a is the MOS itself. Option c is 1/0.40. Higher MOS means lower DOL and lower business risk.
Where it goes wrong. Using MOS directly instead of its reciprocal.
Question 13 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A company has 10% debt of ₹60,00,000 and 12% preference share capital of ₹20,00,000. The tax rate is 25%. What is the financial break-even level of EBIT?
A company has 10% debt of ₹60,00,000 and 12% preference share capital of ₹20,00,000. The tax rate is 25%. What is the financial break-even level of EBIT?
₹9,20,000 (correct answer)
₹8,40,000
₹6,00,000
₹10,00,000
Answer: A — ₹9,20,000
Explanation. Interest = ₹60,00,000 × 10% = ₹6,00,000. Preference dividend = ₹20,00,000 × 12% = ₹2,40,000. Financial BEP is the EBIT at which EPS is zero: EBIT = Interest + Preference dividend / (1 − tax) = ₹6,00,000 + ₹2,40,000 / 0.75 = ₹6,00,000 + ₹3,20,000 = ₹9,20,000. Option b adds preference dividend without grossing up for tax. Option c is only interest.
Where it goes wrong. Ignoring the tax gross-up on preference dividend.
Question 14 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A firm has EBIT of ₹30,00,000, interest of ₹5,00,000, 10% preference capital of ₹10,00,000, tax rate 30% and 5,00,000 equity shares. What is its EPS?
A firm has EBIT of ₹30,00,000, interest of ₹5,00,000, 10% preference capital of ₹10,00,000, tax rate 30% and 5,00,000 equity shares. What is its EPS?
₹3.50
₹3.30 (correct answer)
₹2.80
₹3.00
Answer: B — ₹3.30
Explanation. EBT = ₹30,00,000 − ₹5,00,000 = ₹25,00,000. Tax = 30% × ₹25,00,000 = ₹7,50,000. PAT = ₹17,50,000. Preference dividend = ₹10,00,000 × 10% = ₹1,00,000. Earnings for equity shareholders = ₹17,50,000 − ₹1,00,000 = ₹16,50,000. EPS = ₹16,50,000 / 5,00,000 shares = ₹3.30. Option a omits preference dividend and gives ₹3.50. Option c deducts tax after preference dividend incorrectly.
Where it goes wrong. Forgetting to deduct preference dividend before computing EPS.
Question 15 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A company has DOL of 1.8 and DFL of 1.25. If sales decline by 20%, by what percentage will EPS decline?
A company has DOL of 1.8 and DFL of 1.25. If sales decline by 20%, by what percentage will EPS decline?
36%
25%
45% (correct answer)
56.25%
Answer: C — 45%
Explanation. DCL = DOL × DFL = 1.8 × 1.25 = 2.25. DCL measures the percentage change in EPS for a 1% change in sales. A 20% decline in sales reduces EPS by 20% × 2.25 = 45%. Option a uses only DOL: 20% × 1.8 = 36%. Option b uses only DFL or the sales decline directly. Option d incorrectly squares the DCL.
Where it goes wrong. Using DOL only or applying the sales decline directly to EPS.
Question 17 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Firm X and Firm Y each have contribution of ₹30,00,000. Firm X has fixed operating cost of ₹20,00,000, while Firm Y has fixed operating cost of ₹5,00,000. Which statement is correct?
Firm X and Firm Y each have contribution of ₹30,00,000. Firm X has fixed operating cost of ₹20,00,000, while Firm Y has fixed operating cost of ₹5,00,000. Which statement is correct?
DOL of X is 3.00 and DOL of Y is 1.20; X has higher business risk. (correct answer)
DOL of X is 1.50 and DOL of Y is 6.00; Y has higher business risk.
Both firms have the same DOL because contribution is equal.
DOL of X is 2.00 and DOL of Y is 1.50; X has lower business risk.
Answer: A — DOL of X is 3.00 and DOL of Y is 1.20; X has higher business risk.
Explanation. Firm X: EBIT = ₹30,00,000 − ₹20,00,000 = ₹10,00,000; DOL = ₹30,00,000 / ₹10,00,000 = 3.00. Firm Y: EBIT = ₹30,00,000 − ₹5,00,000 = ₹25,00,000; DOL = ₹30,00,000 / ₹25,00,000 = 1.20. Higher DOL indicates higher business risk, so X has higher business risk despite equal contribution. Option b inverts the fixed-cost effect.
Where it goes wrong. Assuming equal contribution means equal operating leverage.
Question 18 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A firm has combined leverage of 2.8 and financial leverage of 1.4. What is its margin of safety?
A firm has combined leverage of 2.8 and financial leverage of 1.4. What is its margin of safety?
40%
50% (correct answer)
60%
70%
Answer: B — 50%
Explanation. DCL = DOL × DFL. Therefore, DOL = DCL / DFL = 2.8 / 1.4 = 2.0. Since DOL = 1 / Margin of safety, MOS = 1 / DOL = 1 / 2.0 = 0.50 or 50%. Option a is 1/DCL × 100, incorrectly using DCL in place of DOL. Option c is 1/DFL × 100.
Where it goes wrong. Using combined leverage instead of operating leverage to find MOS.
Question 20 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A company reports that a 10% increase in sales causes a 25% increase in EBIT, while a 15% increase in EBIT causes a 30% increase in EPS. What is its Degree of Combined Leverage (DCL)?
A company reports that a 10% increase in sales causes a 25% increase in EBIT, while a 15% increase in EBIT causes a 30% increase in EPS. What is its Degree of Combined Leverage (DCL)?
4.00 times
3.50 times
4.50 times
5.00 times (correct answer)
Answer: D — 5.00 times
Explanation. DOL = % change in EBIT / % change in sales = 25% / 10% = 2.5. DFL = % change in EPS / % change in EBIT = 30% / 15% = 2.0. DCL = DOL × DFL = 2.5 × 2.0 = 5.00 times. Alternatively, DCL = % change in EPS / % change in sales, but the sales and EPS changes are not directly linked here. Option a uses 2.0 × 2.0. Option c averages the two percentages incorrectly.
Where it goes wrong. Adding or averaging percentage changes instead of multiplying DOL and DFL.
What does this Financing Decisions - Leverages - Test 1 practice test cover?
This practice test carries 40 marks across 20 questions covering core concepts, mathematical financial models, strategic management frameworks, and practical ICAI case scenarios.
How many questions are there and what is the time limit?
There are 20 questions carrying 2 marks each, giving a maximum score of 40 marks in 45 minutes with no negative marking.
Which study material and syllabus apply to these questions?
Questions strictly reflect the official ICAI Study Material for CA Intermediate Paper 6 Financial Management and Strategic Management for the 2027 examination sessions.
Can I sit this test in both exam and practice modes?
Yes. Practice mode gives immediate answers with step-by-step workings and trap explanations after each question. Exam mode simulates actual exam conditions with a live timer and issues a downloadable performance certificate.
