Test 3: Financing Decisions - Leverages: answer key
This chapter-wise practice test covers Financing Decisions - Leverages - Test 3 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 · hard
Scenario. Ashoka Steel Ltd. is a prominent manufacturer of specialized alloy steel. The company operates in a highly capital-intensive industry, resulting in a high proportion of fixed operating costs in its cost structure. The CFO is currently evaluating the firm's total risk profile before finalizing the FY 2026-27 financial plan. The following financial data has been extracted from the company's books:
| Particulars | Amount/Rate |
|---|---|
| Sales | ₹2,00,00,000 |
| Variable Cost | 50% of sales |
| Fixed Operating Cost | ₹60,00,000 |
| 10% Term Loan | ₹1,00,00,000 |
| 10% Preference Shares | ₹60,00,000 |
| Equity Shares (₹10 each) | 10,00,000 shares |
| Corporate Tax Rate | 40% |
The company has no other debt or preference capital. The management is concerned about the combined effect of operating and financial leverage on the earnings available to equity shareholders. The CFO wants to measure the Degree of Operating Leverage (DOL), Degree of Financial Leverage (DFL) and Degree of Combined Leverage (DCL). The board has also requested an analysis of the impact on Earnings Per Share (EPS) if the company's EBIT declines by 20% due to a temporary market slowdown. All interest and preference dividend payments are expected to be paid on time.
For Ashoka Steel Ltd, what are the Degree of Operating Leverage (DOL) and Degree of Financial Leverage (DFL) respectively at the current level?
Question 2 · 2 marks · Financing Decisions - Leverages · medium
What is the Degree of Combined Leverage (DCL) for Ashoka Steel Ltd?
5.00 times (correct answer)
6.00 times
3.33 times
4.00 times
Answer: A — 5.00 times
Explanation. DOL = 2.5 and DFL = 2.0. DCL = DOL × DFL = 2.5 × 2.0 = 5.00 times. Option d is a trap from adding DOL and DFL (2.5 + 2.0 = 4.5) or incorrectly using contribution divided by EBT. DCL measures the effect of a change in sales on EPS, showing that a 1% change in sales will lead to a 5% change in EPS.
Where it goes wrong. Adding DOL and DFL instead of multiplying them.
Question 3 · 2 marks · Financing Decisions - Leverages · hard
If the EBIT of Ashoka Steel Ltd declines by 20%, what will be the new Earnings Per Share (EPS)?
₹0.96
₹0.72 (correct answer)
₹0.60
₹0.84
Answer: B — ₹0.72
Explanation. Current EBT = ₹40,00,000 − ₹10,00,000 = ₹30,00,000. Tax = 40% of ₹30,00,000 = ₹12,00,000. PAT = ₹18,00,000. Preference dividend = ₹6,00,000. Earnings for equity = ₹12,00,000. Current EPS = ₹12,00,000 / 10,00,000 shares = ₹1.20. DFL = 2.0, so a 20% fall in EBIT reduces EPS by 40%. New EPS = ₹1.20 × (1 − 0.40) = ₹0.72. Option a is a trap from applying the EBIT decline directly to EPS without DFL magnification.
Where it goes wrong. Applying the EBIT decline directly to EPS without DFL magnification.
Question 4 · 2 marks · Financing Decisions - Leverages · medium
How would you characterize the total risk profile of Ashoka Steel Ltd.?
High Business Risk and Low Financial Risk
Low Business Risk and High Financial Risk
High Business Risk and High Financial Risk (correct answer)
Low Business Risk and Low Financial Risk
Answer: C — High Business Risk and High Financial Risk
Explanation. The company has a DOL of 2.5, indicating high business risk due to a high proportion of fixed operating costs in its capital-intensive industry. It also has a DFL of 2.0, indicating high financial risk due to substantial fixed financial charges (interest and preference dividend). The combination of high DOL and high DFL results in a very risky total risk profile (DCL = 5.0). Option a is a trap from assuming high operating leverage always implies low financial risk.
Where it goes wrong. Assuming that a high DOL implies low financial risk or vice versa.
Question 5 · 2 marks · Financing Decisions - Leverages · medium
Scenario. Meera FMCG Ltd. operates in the highly competitive personal care segment. The company has a flexible cost structure with a lower proportion of fixed operating costs compared to capital-intensive industries, but it relies heavily on debt financing to fund its growth. The following figures have been finalized for the year ended 31 March 2027:
| Particulars | Amount/Rate |
|---|---|
| Sales | ₹1,25,00,000 |
| Variable Cost | 70% of sales |
| Fixed Operating Cost | ₹12,50,000 |
| 10% Debentures | ₹1,25,00,000 |
| Equity Shares (₹10 each) | 5,00,000 shares |
| Corporate Tax Rate | 30% |
The company has no preference share capital. The products are mature, and the management expects a stable EBIT of ₹25,00,000 for the current year. The CFO wants to assess the firm's risk profile to determine if the current financing mix is optimal. The finance team has been asked to compute the DOL, DFL, and DCL. Additionally, the marketing team has projected a 20% increase in sales following a successful promotional campaign. The CFO wants to know the expected EPS after this increase in sales, assuming the selling price and cost structure remain unchanged. The company follows a constant tax rate and has no deferred tax adjustments.
For Meera FMCG Ltd, what are the Degree of Operating Leverage (DOL) and Degree of Financial Leverage (DFL) respectively?
2.0 and 1.5 times
1.5 and 2.0 times (correct answer)
1.5 and 1.5 times
1.25 and 2.0 times
Answer: B — 1.5 and 2.0 times
Explanation. Contribution = ₹1,25,00,000 − (70% of ₹1,25,00,000) = ₹37,50,000. EBIT = ₹37,50,000 − ₹12,50,000 = ₹25,00,000. DOL = ₹37,50,000 / ₹25,00,000 = 1.5. Interest = 10% of ₹1,25,00,000 = ₹12,50,000. DFL = EBIT / (EBIT − Interest) = ₹25,00,000 / (₹25,00,000 − ₹12,50,000) = 2.0. Option d is a trap from using net income instead of EBIT in the DFL numerator.
Where it goes wrong. Using contribution instead of EBIT in the numerator for DFL.
Question 7 · 2 marks · Financing Decisions - Leverages · hard
If the sales of Meera FMCG Ltd increase by 20%, what will be the new Earnings Per Share (EPS)?
₹2.10
₹2.80 (correct answer)
₹2.45
₹3.50
Answer: B — ₹2.80
Explanation. Current EBT = ₹25,00,000 − ₹12,50,000 = ₹12,50,000. Tax = 30% of ₹12,50,000 = ₹3,75,000. PAT = ₹8,75,000. Current EPS = ₹8,75,000 / 5,00,000 shares = ₹1.75. DCL = 3.0, so a 20% increase in sales increases EPS by 60%. New EPS = ₹1.75 × 1.60 = ₹2.80. Option a is a trap from applying only the sales increase to EPS (₹1.75 × 1.20 = ₹2.10) without DCL magnification.
Where it goes wrong. Applying the sales increase directly to EPS without DCL magnification.
Question 8 · 2 marks · Financing Decisions - Leverages · hard
Which of the following statements correctly describes Meera FMCG's risk profile?
Lower business risk is balanced by higher financial risk. (correct answer)
Higher business risk is balanced by lower financial risk.
Both business and financial risks are high, making it very risky.
Both business and financial risks are low, making it the safest option.
Answer: A — Lower business risk is balanced by higher financial risk.
Explanation. Meera FMCG has a DOL of 1.5 (relatively low business risk) and a DFL of 2.0 (high financial risk). The low fixed operating costs reduce business risk, while the high debt levels increase financial risk. The total risk (DCL = 3.0) is moderate. This is a classic risk-balancing profile where lower business risk is offset by higher financial risk. Option b is a trap from reversing the DOL and DFL values.
Where it goes wrong. Assuming both risks must be high or low simultaneously without analyzing DOL and DFL separately.
Question 9 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A firm has a Degree of Operating Leverage (DOL) of 3 and a Degree of Financial Leverage (DFL) of 2. Its interest expense is ₹5,00,000. What is its fixed operating cost?
A firm has a Degree of Operating Leverage (DOL) of 3 and a Degree of Financial Leverage (DFL) of 2. Its interest expense is ₹5,00,000. What is its fixed operating cost?
Question 10 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Karan Ltd has EBIT of ₹20,00,000, interest of ₹5,00,000 and preference dividend of ₹3,00,000. If the tax rate is 40%, what is its Degree of Financial Leverage (DFL)?
Karan Ltd has EBIT of ₹20,00,000, interest of ₹5,00,000 and preference dividend of ₹3,00,000. If the tax rate is 40%, what is its Degree of Financial Leverage (DFL)?
1.82 times
2.22 times
1.60 times
2.00 times (correct answer)
Answer: D — 2.00 times
Explanation. Grossed-up preference dividend = ₹3,00,000 / (1 − 0.40) = ₹5,00,000. DFL = EBIT / (EBIT − Interest − Grossed-up PD) = ₹20,00,000 / (₹20,00,000 − ₹5,00,000 − ₹5,00,000) = ₹20,00,000 / ₹10,00,000 = 2.00. Option c is a trap from ignoring the gross-up of preference dividend and using ₹3,00,000 directly, which gives DFL = 20 / (20 − 5 − 3) = 1.67.
Where it goes wrong. Ignoring the tax gross-up on preference dividend while calculating DFL.
Question 11 · 2 marks · Financing Decisions - Leverages · medium
Scenario. A firm has a Degree of Combined Leverage (DCL) of 4. If sales decrease by 15%, by what percentage will Earnings Per Share (EPS) decrease?
A firm has a Degree of Combined Leverage (DCL) of 4. If sales decrease by 15%, by what percentage will Earnings Per Share (EPS) decrease?
60% (correct answer)
45%
15%
75%
Answer: A — 60%
Explanation. DCL measures the percentage change in EPS for a given percentage change in sales. DCL = % change in EPS / % change in Sales. 4 = % change in EPS / 15%. % change in EPS = 4 × 15% = 60%. Option b is a trap from using only DOL or DFL individually, leading to an incorrect percentage change.
Where it goes wrong. Using DOL or DFL individually instead of DCL.
Question 12 · 2 marks · Financing Decisions - Leverages · medium
Scenario. A company has a Return on Investment (ROI) of 15% and after-tax cost of debt of 9%. According to the concept of trading on equity, what will be the effect of increasing debt in the capital structure?
A company has a Return on Investment (ROI) of 15% and after-tax cost of debt of 9%. According to the concept of trading on equity, what will be the effect of increasing debt in the capital structure?
EPS will decrease
EPS will increase (correct answer)
EPS will remain unchanged
Cannot be determined
Answer: B — EPS will increase
Explanation. Trading on equity is favourable when the Return on Investment (ROI) exceeds the after-tax cost of debt. Here, ROI = 15% and after-tax cost of debt = 9%. The positive spread of 6% (15% − 9%) will accrue to equity shareholders, thereby increasing EPS. Option a is a trap from believing that increasing debt always increases financial risk and decreases EPS, ignoring the ROI vs. cost of debt comparison.
Where it goes wrong. Believing that increasing debt always decreases EPS regardless of ROI.
Question 13 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Firm A has DOL of 4 and DFL of 1.5. Firm B has DOL of 1.5 and DFL of 4. Both have the same DCL. Which firm has a higher financial risk?
Firm A has DOL of 4 and DFL of 1.5. Firm B has DOL of 1.5 and DFL of 4. Both have the same DCL. Which firm has a higher financial risk?
Firm A
Both have equal financial risk
Cannot be compared based on DCL
Firm B (correct answer)
Answer: D — Firm B
Explanation. Financial risk is measured by the Degree of Financial Leverage (DFL). Firm A has a DFL of 1.5, while Firm B has a DFL of 4. A higher DFL indicates that fixed financial charges magnify the effect of EBIT changes on EPS to a greater extent. Therefore, Firm B has higher financial risk. Option b is a trap from assuming that because both firms have the same DCL, their financial risk is equal.
Where it goes wrong. Assuming that equal DCL implies equal financial risk.
Question 14 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A company has DCL of 3, DFL of 2, Interest of ₹10,00,000, Tax of 30%, Sales of ₹1,00,00,000 and 1,00,000 equity shares. What is its Earnings Per Share (EPS)?
A company has DCL of 3, DFL of 2, Interest of ₹10,00,000, Tax of 30%, Sales of ₹1,00,00,000 and 1,00,000 equity shares. What is its Earnings Per Share (EPS)?
₹5.00
₹10.00
₹3.50
₹7.00 (correct answer)
Answer: D — ₹7.00
Explanation. DFL = 2 => EBIT = 2 × EBT. Since EBT = EBIT − ₹10,00,000, we get EBIT = ₹20,00,000 and EBT = ₹10,00,000. DOL = 1.5 => Contribution = 1.5 × EBIT = ₹30,00,000. EBIT = ₹20,00,000 implies Tax = 30% of ₹10,00,000 = ₹3,00,000. PAT = ₹7,00,000. EPS = ₹7,00,000 / 1,00,000 = ₹7.00. Option a is a trap from computing PAT divided by total capital instead of the number of equity shares.
Where it goes wrong. Using total capital instead of the number of shares in the EPS denominator.
Question 15 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Surya Ltd has Sales of ₹80,00,000, Variable Cost of ₹40,00,000, Fixed Cost of ₹20,00,000, Interest of ₹5,00,000, and Preference Dividend of ₹4,20,000. The tax rate is 30%. What is its Degree of Combined Leverage (DCL)?
Surya Ltd has Sales of ₹80,00,000, Variable Cost of ₹40,00,000, Fixed Cost of ₹20,00,000, Interest of ₹5,00,000, and Preference Dividend of ₹4,20,000. The tax rate is 30%. What is its Degree of Combined Leverage (DCL)?
Question 16 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Which of the following combinations of DOL and DFL represents the highest total risk?
Which of the following combinations of DOL and DFL represents the highest total risk?
DOL 4.0, DFL 2.0 (correct answer)
DOL 5.0, DFL 1.5
DOL 3.0, DFL 2.5
DOL 2.0, DFL 3.0
Answer: A — DOL 4.0, DFL 2.0
Explanation. Total risk is measured by the Degree of Combined Leverage (DCL = DOL × DFL). Option a: DCL = 4.0 × 2.0 = 8.0. Option b: 5.0 × 1.5 = 7.5. Option c: 3.0 × 2.5 = 7.5. Option d: 2.0 × 3.0 = 6.0. The highest DCL indicates the highest total risk. Option b is a trap from choosing the highest DOL individually rather than their product.
Where it goes wrong. Choosing the highest DOL or DFL individually instead of the highest DCL.
Question 17 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A firm has a Degree of Combined Leverage (DCL) of 3.6 and a Degree of Financial Leverage (DFL) of 1.8. What is its Degree of Operating Leverage (DOL)?
A firm has a Degree of Combined Leverage (DCL) of 3.6 and a Degree of Financial Leverage (DFL) of 1.8. What is its Degree of Operating Leverage (DOL)?
1.5 times
6.48 times
2.0 times (correct answer)
1.8 times
Answer: C — 2.0 times
Explanation. DCL = DOL × DFL. Therefore, DOL = DCL / DFL = 3.6 / 1.8 = 2.0. Option b is a trap from multiplying DCL and DFL (3.6 × 1.8 = 6.48) instead of dividing them.
Where it goes wrong. Multiplying DCL and DFL instead of dividing to find DOL.
Question 18 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A firm has a DOL of 2. Its fixed operating cost is ₹15,00,000 and it is currently operating at a sales level of ₹50,00,000. If sales increase by 15%, what will be the new EBIT?
A firm has a DOL of 2. Its fixed operating cost is ₹15,00,000 and it is currently operating at a sales level of ₹50,00,000. If sales increase by 15%, what will be the new EBIT?
₹15,00,000
₹22,50,000
₹24,00,000
₹19,50,000 (correct answer)
Answer: D — ₹19,50,000
Explanation. DOL = 2, and Fixed Cost = ₹15,00,000. Since DOL = Contribution / EBIT and Contribution = EBIT + Fixed Cost, we have 2 = (EBIT + 15,00,000) / EBIT. 2 EBIT = EBIT + 15,00,000 => EBIT = ₹15,00,000. A 15% increase in sales increases EBIT by DOL × 15% = 2 × 15% = 30%. New EBIT = ₹15,00,000 × 1.30 = ₹19,50,000. Option b is a trap from calculating the new contribution only (₹30,00,000 × 1.15 = ₹34,50,000) and subtracting the old EBIT instead of fixed costs.
Where it goes wrong. Calculating the new contribution and forgetting to subtract fixed costs to find EBIT.
Question 19 · 2 marks · Financing Decisions - Leverages · hard
Scenario. A company has interest expense of ₹8,00,000, fixed operating cost of ₹16,00,000, and a P/V ratio of 40%. The tax rate is 25% and the number of equity shares is 4,00,000. What sales level is required to achieve an EPS of ₹3.00?
A company has interest expense of ₹8,00,000, fixed operating cost of ₹16,00,000, and a P/V ratio of 40%. The tax rate is 25% and the number of equity shares is 4,00,000. What sales level is required to achieve an EPS of ₹3.00?
₹1,20,00,000
₹1,40,00,000
₹1,60,00,000
₹1,00,00,000 (correct answer)
Answer: D — ₹1,00,00,000
Explanation. Target PAT = EPS × Number of shares = ₹3.00 × 4,00,000 = ₹12,00,000. Target EBT = PAT / (1 − tax) = ₹12,00,000 / 0.75 = ₹16,00,000. Target EBIT = EBT + Interest = ₹16,00,000 + ₹8,00,000 = ₹24,00,000. Target Contribution = EBIT + Fixed Cost = ₹24,00,000 + ₹16,00,000 = ₹40,00,000. Required Sales = Contribution / P/V ratio = ₹40,00,000 / 0.40 = ₹1,00,00,000. Option c is a trap from forgetting to add fixed costs to the target EBIT.
Where it goes wrong. Ignoring fixed costs while computing the required sales level.
Question 20 · 2 marks · Financing Decisions - Leverages · hard
Scenario. Which of the following is true regarding the relationship between risk and leverage?
Which of the following is true regarding the relationship between risk and leverage?
DOL measures financial risk, while DFL measures business risk.
A firm with high DOL and low DFL has the highest total risk.
Financial leverage has no impact on a firm's total risk.
DCL measures total risk, which is the product of business risk and financial risk. (correct answer)
Answer: D — DCL measures total risk, which is the product of business risk and financial risk.
Explanation. The Degree of Combined Leverage (DCL) combines the effects of both operating and financial leverage. It measures the percentage change in EPS resulting from a percentage change in sales, thereby representing the total risk (business risk + financial risk) faced by the firm. DOL measures business risk, and DFL measures financial risk. Option a is a trap from confusing the measures of business and financial risk.
Where it goes wrong. Confusing the measures of business and financial risk.
What does this Financing Decisions - Leverages - Test 3 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.
