Test 1: Investment Decisions (Capital Budgeting): answer key
This chapter-wise practice test covers Investment Decisions (Capital Budgeting) - Test 1 for CA Intermediate Group 2 students preparing for the May 2027 examination attempt. It carries 50 marks across 25 questions in case scenarios and standalone practical MCQs with a time limit of 60 minutes and no negative marking.
25 questions across 1 chapter, 50 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 2027 attempt).
Questions
25
Marks
50
Time limit
60 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
Investment Decisions (Capital Budgeting) (25 Q)
Questions, answers and explanations
Question 1 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. Bharat Renewables Ltd is considering a four-year production line to meet confirmed orders from solar-park developers. It will be installed at an existing plant, but all operating estimates below are incremental to current operations. A feasibility report costing ₹3 lakh was paid for last year; it is irrecoverable and is excluded from project cash flows.
The company’s long-term financing mix is 55% equity and 45% term debt carrying a 9.5% coupon. Treasury has separately approved a post-tax project WACC of 10%, which must be used as the discount rate. The tax rate is 30%. Do not deduct interest or dividends in computing project operating cash flows.
**Project data (₹ lakh)**
| Particulars | Amount / details |
|---|---:|
| Machine purchase price | 120 |
| Installation | 10 |
| Initial net working capital | 15 |
| Useful life | 4 years |
| Annual depreciation | 30 |
| Year-4 sale proceeds | 14 |
| Tax WDV at disposal | 10 |
| Year-1 EBDIT | 60 |
| Year-2 EBDIT | 70 |
| Year-3 EBDIT | 80 |
| Year-4 EBDIT | 75 |
| Tax rate / WACC | 30% / 10% |
| PV factors (Years 1-4) | 0.909, 0.826, 0.751, 0.683 |
EBDIT is the annual cash operating surplus before depreciation, interest and tax. Depreciation is allowable for tax at the stated amount. Any disposal gain is taxable at 30%. The machine is the only asset in its tax block, which ceases on disposal. The full initial working-capital amount remains invested until the end of Year 4 and is then realised; there are no other working-capital changes. Assume all annual operating flows and terminal adjustments occur at year-end, with no other tax adjustments or additional capital expenditure. Use the supplied discount factors.
What is the initial cash outflow at Year 0 for the proposed production line?
₹130 lakh
₹145 lakh (correct answer)
₹148 lakh
₹160 lakh
Answer: B — ₹145 lakh
Explanation. Initial outflow includes the machine purchase price, installation and initial working capital. Therefore, ₹120 lakh + ₹10 lakh + ₹15 lakh = ₹145 lakh. The ₹3 lakh feasibility report was paid last year and is irrecoverable, so it is a sunk cost and must be excluded. Option a omits working capital; option c improperly adds the sunk report; option d overstates the stated project investment.
Where it goes wrong. Including a previously paid feasibility fee or omitting the initial working-capital requirement.
Question 2 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Calculate the Year 2 cash flow after tax (CFAT) from project operations, before any terminal adjustments.
₹49 lakh
₹40 lakh
₹70 lakh
₹58 lakh (correct answer)
Answer: D — ₹58 lakh
Explanation. Year 2 EBDIT is ₹70 lakh and depreciation is ₹30 lakh. EBIT = ₹70 lakh − ₹30 lakh = ₹40 lakh; tax at 30% is ₹12 lakh; EAT is ₹28 lakh. Add back the non-cash depreciation of ₹30 lakh: CFAT = ₹28 lakh + ₹30 lakh = ₹58 lakh. Option b is EAT, not cash flow; option a deducts tax from EBDIT without correctly applying the depreciation tax shield.
Where it goes wrong. Reporting accounting profit after tax instead of adding back depreciation to obtain CFAT.
Question 3 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Determine the total net cash flow in Year 4, including the operating CFAT, disposal proceeds after tax and release of working capital.
₹89.30 lakh (correct answer)
₹75.50 lakh
₹90.50 lakh
₹104.30 lakh
Answer: A — ₹89.30 lakh
Explanation. Year 4 EBIT is ₹75 lakh − ₹30 lakh = ₹45 lakh. Tax is ₹13.50 lakh, so EAT is ₹31.50 lakh; adding depreciation gives operating CFAT of ₹61.50 lakh. Tax WDV at disposal is ₹10 lakh and sale proceeds are ₹14 lakh, creating a taxable gain of ₹4 lakh and tax of ₹1.20 lakh; net sale proceeds are ₹12.80 lakh. Add the ₹15 lakh working-capital release: ₹61.50 + ₹12.80 + ₹15 = ₹89.30 lakh.
Where it goes wrong. Adding gross salvage proceeds without tax, or forgetting the release of working capital.
Question 4 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Using the supplied 10% present-value factors, calculate the project's NPV.
₹44.07 lakh
₹74.07 lakh
₹59.07 lakh (correct answer)
₹89.30 lakh
Answer: C — ₹59.07 lakh
Explanation. The post-tax cash flows are ₹51 lakh, ₹58 lakh, ₹65 lakh and ₹89.30 lakh, with the final amount including salvage after tax and working-capital release. Their present values are 51×0.909 = ₹46.359 lakh; 58×0.826 = ₹47.908 lakh; 65×0.751 = ₹48.815 lakh; and 89.30×0.683 = ₹60.992 lakh. Total PV is ₹204.074 lakh. NPV = ₹204.074 − ₹145 = ₹59.074 lakh, or ₹59.07 lakh. Option d is the terminal cash flow, not NPV.
Where it goes wrong. Subtracting only the machine price rather than the full initial outlay, or treating terminal cash flow as NPV.
Question 5 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Zenith Power Systems Ltd is considering replacing an ageing turbine with a modern unit. The replacement is expected to improve reliability and reduce operating costs. The analysis must use incremental cash flows; the old turbine’s historical purchase price is irrelevant. It is the only asset in its tax block, and the block ceases when the turbine is sold. Assume the disposal tax effect is immediately available.
The company’s financing mix is 60% equity and 40% long-term debt carrying an 8.75% coupon. The approved post-tax project discount rate is 9.5%. Use a 30% tax rate and exclude financing costs from operating cash flows.
**Replacement data (₹ lakh)**
| Particulars | Amount / details |
|---|---:|
| New turbine cost / installation | 90 / 6 |
| Old turbine sale proceeds | 18 |
| Old turbine tax WDV before sale | 24 |
| Existing / revised working capital | 12 / 17 |
| New turbine useful life | 5 years |
| New turbine residual value in Year 5 | 16 |
| Annual depreciation: new / old | 16 / 5 |
| Annual increase in operating revenue | 48 |
| Annual increase in cash operating expenses | 20 |
| Tax rate | 30% |
Incremental revenue and cash expenses remain constant for five years. The stated depreciation amounts are the relevant annual charges for measuring the change in taxable operating profit. There are no other incremental overheads, tax allowances, capital expenditures or working-capital changes. At the end of Year 5, the new turbine is sold for ₹16 lakh, equal to its tax WDV, and the additional working capital is fully released. Annual operating cash flows and terminal adjustments occur at year-end. Compute only the replacement proposal’s cash flows.
Calculate the initial net cash outflow for replacing the old turbine.
₹78.20 lakh
₹81.20 lakh (correct answer)
₹83.00 lakh
₹101.00 lakh
Answer: B — ₹81.20 lakh
Explanation. New turbine and installation cost ₹90 lakh + ₹6 lakh = ₹96 lakh. Working capital rises from ₹12 lakh to ₹17 lakh, so the incremental outflow is ₹5 lakh. The old turbine is sold for ₹18 lakh; its tax WDV is ₹24 lakh, creating a ₹6 lakh short-term capital loss and tax saving of ₹6 lakh×30% = ₹1.80 lakh. Initial outflow = ₹96 + ₹5 − ₹18 − ₹1.80 = ₹81.20 lakh. Option d ignores the disposal proceeds and tax benefit.
Where it goes wrong. Omitting the tax saving on disposal loss or deducting the entire revised working-capital balance instead of its increase.
Question 6 · 2 marks · Investment Decisions (Capital Budgeting) · hard
What is the immediate tax effect of selling the old turbine, given that it is the only asset in its tax block and the block ceases to exist?
Tax outflow of ₹1.80 lakh
No tax effect
Tax outflow of ₹6.00 lakh
Tax saving of ₹1.80 lakh (correct answer)
Answer: D — Tax saving of ₹1.80 lakh
Explanation. The old turbine's tax WDV is ₹24 lakh while its sale proceeds are ₹18 lakh. Since the sole-asset block ceases to exist, the difference of ₹6 lakh is a short-term capital loss under the stated assumption. At 30%, the loss produces a tax saving of ₹6 lakh×30% = ₹1.80 lakh. It is a cash-flow benefit and reduces the replacement project's initial net outflow. Option a reverses the direction of the tax effect.
Where it goes wrong. Treating sale proceeds below tax WDV as a taxable gain instead of a loss and tax saving.
Question 7 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the annual incremental CFAT generated by the replacement, before working-capital movements and terminal proceeds.
₹22.90 lakh (correct answer)
₹17.00 lakh
₹28.00 lakh
₹33.90 lakh
Answer: A — ₹22.90 lakh
Explanation. Incremental depreciation is ₹16 lakh on the new turbine less ₹5 lakh on the old turbine, or ₹11 lakh. Incremental EBIT = revenue increase ₹48 lakh − cash expense increase ₹20 lakh − depreciation increase ₹11 lakh = ₹17 lakh. Tax at 30% is ₹5.10 lakh, leaving incremental PAT of ₹11.90 lakh. Add back the incremental non-cash depreciation of ₹11 lakh: CFAT = ₹22.90 lakh. Option b is incremental EBIT, not cash flow after tax.
Where it goes wrong. Adding back all new depreciation without deducting the old depreciation that ceases, or stopping at incremental EBIT.
Question 8 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Determine the total net cash flow in Year 5, including annual incremental CFAT, sale of the new turbine and release of additional working capital.
₹22.90 lakh
₹38.90 lakh
₹43.90 lakh (correct answer)
₹48.90 lakh
Answer: C — ₹43.90 lakh
Explanation. The Year 5 incremental operating CFAT is ₹22.90 lakh. The new turbine is sold for ₹16 lakh, equal to its tax WDV, so there is no taxable gain or loss and the full ₹16 lakh is received. The incremental working-capital investment of ₹5 lakh is also released. Terminal-year cash flow = ₹22.90 + ₹16 + ₹5 = ₹43.90 lakh. Option b omits working-capital release, while option d overstates the release by using the total revised working-capital level.
Where it goes wrong. Omitting working-capital release or applying tax to a sale price that equals the tax WDV.
Question 9 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Aditya Automotive Ltd plans to automate a component-assembly facility. Two mutually exclusive production cells, A and B, have been shortlisted. Only one can be installed because both require the same floor area and production connection. The company’s financing mix is 55% equity and 45% term debt carrying a 9% coupon. Treasury has determined a post-tax WACC of 10%; use it as the discount and reinvestment rate.
The estimates below are project-specific net cash inflows after tax, operating costs, depreciation tax effects and working-capital movements. They are not accounting profits. There are no subsequent investments, salvage proceeds or further working-capital releases. Each annual inflow occurs at year-end.
**Project cash flows (₹ lakh)**
| Year | Project A | Project B |
|---:|---:|---:|
| 0 - initial outflow | (70) | (80) |
| 1 - net inflow | 25 | 20 |
| 2 - net inflow | 25 | 28 |
| 3 - net inflow | 25 | 32 |
| 4 - net inflow | 25 | 34 |
**PV factors at 10%:** Year 1: 0.909; Year 2: 0.826; Year 3: 0.751; Year 4: 0.683.
The capital budget can fund either proposal but not both. The board will select the alternative producing the greater addition to shareholders’ wealth, while also reviewing relative profitability and the recovery period. For MIRR, assume interim positive inflows are reinvested at 10% through the end of Year 4. Do not deduct interest or dividends from the given cash flows. Use the supplied three-decimal factors where relevant.
Calculate the NPV of Projects A and B at 10% and identify the proposal that should be selected on the NPV criterion.
A: ₹9.23 lakh; B: ₹8.56 lakh; select B
A: ₹8.56 lakh; B: ₹9.23 lakh; select B
A: ₹8.56 lakh; B: ₹9.23 lakh; select A
A: ₹9.23 lakh; B: ₹8.56 lakh; select A (correct answer)
Answer: D — A: ₹9.23 lakh; B: ₹8.56 lakh; select A
Explanation. For A, PV of inflows = 25×(0.909+0.826+0.751+0.683) = 25×3.169 = ₹79.225 lakh; NPV = ₹79.225−₹70 = ₹9.225 lakh. For B, PV = 20×0.909 + 28×0.826 + 32×0.751 + 34×0.683 = ₹88.562 lakh; NPV = ₹88.562−₹80 = ₹8.562 lakh. Project A has the higher NPV and is selected. Option a has the NPVs right but reverses the decision.
Where it goes wrong. Selecting the alternative with the larger initial outlay or reversing the NPV comparison.
Question 10 · 2 marks · Investment Decisions (Capital Budgeting) · medium
What is the Profitability Index (PI) of Project A?
0.132
1.132 (correct answer)
1.268
1.322
Answer: B — 1.132
Explanation. The PV of Project A's inflows is ₹79.225 lakh, calculated as ₹25 lakh multiplied by the sum of the four supplied factors (3.169). PI = PV of cash inflows ÷ initial cash outlay = ₹79.225 ÷ ₹70 = 1.1318, approximately 1.132. Since PI exceeds 1, the proposal is acceptable on a standalone accept-reject basis. Option a is the NPV-to-investment ratio, not PI; option d uses an incorrect denominator or factor total.
Where it goes wrong. Confusing PI with NPV divided by investment, or dividing by the wrong cash-flow amount.
Question 11 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the discounted payback period of Project A at 10%, using the supplied present-value factors.
3.46 years (correct answer)
2.80 years
3.00 years
3.92 years
Answer: A — 3.46 years
Explanation. Discounted inflows for Years 1-4 are ₹22.725 lakh, ₹20.650 lakh, ₹18.775 lakh and ₹17.075 lakh. Cumulative PV through Year 3 is ₹62.150 lakh, leaving ₹70−₹62.150 = ₹7.850 lakh unrecovered. The fraction of Year 4 required is ₹7.850÷₹17.075 = 0.4597. Discounted payback = 3 + 0.4597 = 3.46 years. Option b is close to a simple-payback style calculation and ignores discounting.
Where it goes wrong. Using undiscounted annual inflows or dividing the unrecovered amount by the undiscounted Year-4 cash flow.
Question 12 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Determine the MIRR of Project B, assuming interim positive cash flows are reinvested at 10% until the end of Year 4.
10.00%
16.21%
12.84% (correct answer)
14.15%
Answer: C — 12.84%
Explanation. Bring each positive cash flow to the end of Year 4 at 10%: Year 1 ₹20×1.1³ = ₹26.62 lakh; Year 2 ₹28×1.1² = ₹33.88 lakh; Year 3 ₹32×1.1 = ₹35.20 lakh; Year 4 = ₹34 lakh. Terminal value = ₹129.70 lakh. MIRR = (₹129.70÷₹80)^(1/4)−1 = 12.84% approximately. Option b mistakes the total growth multiple for an annual rate; option a merely repeats the reinvestment rate.
Where it goes wrong. Applying the reinvestment rate as the MIRR or failing to compound earlier cash inflows to the terminal year.
Question 13 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project is expected to generate annual sales of ₹48 lakh, cash operating expenses of ₹26 lakh and depreciation of ₹8 lakh. If the tax rate is 25%, calculate annual CFAT.
A project is expected to generate annual sales of ₹48 lakh, cash operating expenses of ₹26 lakh and depreciation of ₹8 lakh. If the tax rate is 25%, calculate annual CFAT.
₹16.50 lakh
₹18.50 lakh (correct answer)
₹22.00 lakh
₹14.00 lakh
Answer: B — ₹18.50 lakh
Explanation. EBIT = sales − cash operating expenses − depreciation = ₹48−₹26−₹8 = ₹14 lakh. Tax at 25% is ₹3.50 lakh, leaving EAT of ₹10.50 lakh. Add back depreciation of ₹8 lakh because it is a non-cash charge. CFAT = ₹10.50 + ₹8 = ₹18.50 lakh. Option d reports EAT; option c applies tax to the wrong base and fails to reflect the depreciation tax shield correctly.
Where it goes wrong. Using accounting earnings after tax as cash flow without adding back depreciation.
Question 14 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project requires a machine costing ₹50 lakh, installation of ₹4 lakh and initial working capital of ₹8 lakh. The company will use its own land, which has a book value of ₹8 lakh and a current sale value of ₹30 lakh. A feasibility study costing ₹2.50 lakh was paid for last year. Calculate the relevant initial cash outflow.
A project requires a machine costing ₹50 lakh, installation of ₹4 lakh and initial working capital of ₹8 lakh. The company will use its own land, which has a book value of ₹8 lakh and a current sale value of ₹30 lakh. A feasibility study costing ₹2.50 lakh was paid for last year. Calculate the relevant initial cash outflow.
₹62 lakh
₹64.50 lakh
₹70 lakh
₹92 lakh (correct answer)
Answer: D — ₹92 lakh
Explanation. The machine, installation and working capital require ₹50 + ₹4 + ₹8 = ₹62 lakh. Using the company's land has an opportunity cost equal to the ₹30 lakh current sale value forgone, so relevant initial outflow is ₹62 + ₹30 = ₹92 lakh. The ₹8 lakh book value is historical and does not measure the current sacrifice. The ₹2.50 lakh study fee is a sunk cost already paid and is excluded. Option a omits the land opportunity cost.
Where it goes wrong. Using historical book cost instead of current opportunity cost, or adding an already-paid feasibility fee.
Question 15 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project generates incremental sales of ₹80 lakh, incremental cash operating expenses of ₹48 lakh and depreciation of ₹8 lakh annually. An allocated corporate overhead of ₹6 lakh will be charged to the project, but it will not increase the company's total cash expenditure. At a 30% tax rate, calculate annual CFAT.
A project generates incremental sales of ₹80 lakh, incremental cash operating expenses of ₹48 lakh and depreciation of ₹8 lakh annually. An allocated corporate overhead of ₹6 lakh will be charged to the project, but it will not increase the company's total cash expenditure. At a 30% tax rate, calculate annual CFAT.
₹24.80 lakh (correct answer)
₹20.60 lakh
₹16.80 lakh
₹30.40 lakh
Answer: A — ₹24.80 lakh
Explanation. The allocated ₹6 lakh overhead is not incremental and is therefore excluded. EBIT = ₹80−₹48−₹8 = ₹24 lakh. Tax at 30% is ₹7.20 lakh, leaving EAT of ₹16.80 lakh. Add back non-cash depreciation of ₹8 lakh: CFAT = ₹24.80 lakh. Option b incorrectly deducts the allocated overhead; option c stops at EAT and omits depreciation add-back. Only an overhead increase caused by accepting the proposal would be relevant.
Where it goes wrong. Treating an existing allocated overhead as an incremental cash outflow or failing to add back depreciation.
Question 16 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project requires initial working capital of ₹8 lakh. An additional ₹3 lakh is invested at the end of Year 2. Working capital is reduced by ₹2 lakh at the end of Year 3. Assuming all remaining working capital is realised when the project ends in Year 4, what is the terminal working-capital inflow?
A project requires initial working capital of ₹8 lakh. An additional ₹3 lakh is invested at the end of Year 2. Working capital is reduced by ₹2 lakh at the end of Year 3. Assuming all remaining working capital is realised when the project ends in Year 4, what is the terminal working-capital inflow?
₹7 lakh
₹8 lakh
₹9 lakh (correct answer)
₹11 lakh
Answer: C — ₹9 lakh
Explanation. The total working capital tied up before release is ₹8 lakh initially plus ₹3 lakh additional investment, or ₹11 lakh. The ₹2 lakh reduction in Year 3 is already a cash inflow and reduces the amount remaining in the project. Therefore, the balance released in Year 4 is ₹11−₹2 = ₹9 lakh. Option b ignores the additional working capital; option d forgets that the Year-3 reduction has already been recovered.
Where it goes wrong. Releasing the original working-capital amount only, or failing to adjust for interim additions and reductions.
Question 17 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. At the end of a project's life, an asset is sold for ₹52 lakh. Its tax WDV immediately before sale is ₹40 lakh. The asset is the only asset in its block and the block ceases on disposal. If the applicable tax rate is 30%, calculate the tax cash outflow arising on disposal.
At the end of a project's life, an asset is sold for ₹52 lakh. Its tax WDV immediately before sale is ₹40 lakh. The asset is the only asset in its block and the block ceases on disposal. If the applicable tax rate is 30%, calculate the tax cash outflow arising on disposal.
₹12 lakh
₹3.60 lakh (correct answer)
₹15.60 lakh
₹2.40 lakh
Answer: B — ₹3.60 lakh
Explanation. Because the only asset in the block is sold and the block ceases, compare sale proceeds with the WDV. Sale proceeds exceed WDV by ₹52−₹40 = ₹12 lakh, giving a taxable short-term capital gain under the stated treatment. Tax cash outflow = ₹12 lakh×30% = ₹3.60 lakh. Option a is the gain before tax, not the tax payment; option c adds tax to the gain rather than calculating the tax alone.
Where it goes wrong. Treating the full sale proceeds as taxable or confusing the taxable gain with the resulting tax payment.
Question 18 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project requires an initial outlay of ₹1,20,000 and generates after-tax cash inflows of ₹30,000, ₹40,000, ₹35,000 and ₹50,000 in Years 1 to 4 respectively. Calculate the payback period.
A project requires an initial outlay of ₹1,20,000 and generates after-tax cash inflows of ₹30,000, ₹40,000, ₹35,000 and ₹50,000 in Years 1 to 4 respectively. Calculate the payback period.
3.00 years
3.50 years
3.70 years
3.30 years (correct answer)
Answer: D — 3.30 years
Explanation. Cumulative inflows are ₹30,000 after Year 1, ₹70,000 after Year 2 and ₹1,05,000 after Year 3. The unrecovered outlay at the end of Year 3 is ₹1,20,000−₹1,05,000 = ₹15,000. Year 4 brings ₹50,000, so the fraction of Year 4 required is ₹15,000÷₹50,000 = 0.30. Payback period = 3.30 years. Option a ignores the remaining amount at the end of Year 3.
Where it goes wrong. Treating payback as a whole number of years or using the full Year-4 cash flow as an extra full year.
Question 19 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A machine costs ₹1,20,000 and has a salvage value of ₹20,000 after its five-year life. Average annual profit after depreciation and tax is ₹24,000. Additional working capital of ₹10,000 is required during the project. Calculate ARR using the average-investment basis.
A machine costs ₹1,20,000 and has a salvage value of ₹20,000 after its five-year life. Average annual profit after depreciation and tax is ₹24,000. Additional working capital of ₹10,000 is required during the project. Calculate ARR using the average-investment basis.
30.00% (correct answer)
20.00%
24.00%
34.29%
Answer: A — 30.00%
Explanation. Average investment, including additional working capital, is ½(Initial investment−Salvage value)+Salvage value+Additional working capital. This equals ½(₹1,20,000−₹20,000)+₹20,000+₹10,000 = ₹50,000+₹20,000+₹10,000 = ₹80,000. The average annual profit after depreciation and tax, already given, is ₹24,000. ARR = ₹24,000÷₹80,000×100 = 30%. Option c omits the additional working capital from average investment. This applies the average-investment version expressly required in the question.
Where it goes wrong. Using initial investment instead of average investment, or omitting additional working capital from average investment.
Question 20 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project requires ₹1,20,000 immediately and is expected to generate cash inflows of ₹50,000, ₹55,000 and ₹60,000 at the end of Years 1, 2 and 3. At 10%, use PV factors of 0.909, 0.826 and 0.751. Calculate NPV.
A project requires ₹1,20,000 immediately and is expected to generate cash inflows of ₹50,000, ₹55,000 and ₹60,000 at the end of Years 1, 2 and 3. At 10%, use PV factors of 0.909, 0.826 and 0.751. Calculate NPV.
₹10,940
₹15,490
₹15,940 (correct answer)
₹25,940
Answer: C — ₹15,940
Explanation. Present value of Year 1 inflow = ₹50,000×0.909 = ₹45,450; Year 2 = ₹55,000×0.826 = ₹45,430; Year 3 = ₹60,000×0.751 = ₹45,060. Total PV of inflows is ₹1,35,940. NPV = ₹1,35,940−₹1,20,000 = ₹15,940. Option d adds the initial outlay instead of deducting it; option b contains an arithmetic error in the discounted Year-2 or Year-3 inflow.
Where it goes wrong. Adding initial investment to PV of inflows or using undiscounted cash flows.
Question 21 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project requires an initial outlay of ₹5,00,000 and an additional outflow of ₹1,00,000 at the end of Year 2. It generates inflows of ₹2,00,000, ₹2,50,000 and ₹2,00,000 at the end of Years 1, 2 and 3. At 10%, PV factors are 0.909, 0.826 and 0.751. Calculate PI using the present value of all cash outflows as the denominator.
A project requires an initial outlay of ₹5,00,000 and an additional outflow of ₹1,00,000 at the end of Year 2. It generates inflows of ₹2,00,000, ₹2,50,000 and ₹2,00,000 at the end of Years 1, 2 and 3. At 10%, PV factors are 0.909, 0.826 and 0.751. Calculate PI using the present value of all cash outflows as the denominator.
1.076
0.924 (correct answer)
1.108
0.880
Answer: B — 0.924
Explanation. PV of inflows = ₹2,00,000×0.909 + ₹2,50,000×0.826 + ₹2,00,000×0.751 = ₹1,81,800+₹2,06,500+₹1,50,200 = ₹5,38,500. PV of outflows = ₹5,00,000 + ₹1,00,000×0.826 = ₹5,82,600. PI = ₹5,38,500÷₹5,82,600 = 0.9243, approximately 0.924. Since PI is below 1, reject. Option a omits the discounted Year-2 outflow; the additional outlay must be discounted from its own date.
Where it goes wrong. Using only the Year-0 outlay as denominator when a later capital outflow is also required.
Question 22 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project costs ₹1,20,000 and produces equal annual cash inflows of ₹40,000 for four years. The PV annuity factor is 3.037 at 12% and 2.974 at 13%. Estimate IRR by interpolation.
A project costs ₹1,20,000 and produces equal annual cash inflows of ₹40,000 for four years. The PV annuity factor is 3.037 at 12% and 2.974 at 13%. Estimate IRR by interpolation.
11.41%
13.16%
12.00%
12.59% (correct answer)
Answer: D — 12.59%
Explanation. At 12%, PV of inflows = ₹40,000×3.037 = ₹1,21,480, giving positive NPV of ₹1,480. At 13%, PV = ₹40,000×2.974 = ₹1,18,960, giving negative NPV of ₹1,040. By interpolation, IRR = 12% + [1,480÷(1,480+1,040)]×1% = 12% + 0.5873% = 12.59% approximately. The interpolation fraction uses the positive NPV divided by the absolute difference between the two trial NPVs. Option c uses the lower test rate without interpolation.
Where it goes wrong. Using the NPV at one trial rate as the IRR instead of interpolating between positive and negative NPVs.
Question 23 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Two mutually exclusive one-year projects are being compared at a 10% cost of capital (PV factor 0.909). Project A costs ₹10 lakh and yields ₹15 lakh; Project B costs ₹100 lakh and yields ₹120 lakh. Which conclusion is correct when NPV is used to maximise shareholders' wealth?
Two mutually exclusive one-year projects are being compared at a 10% cost of capital (PV factor 0.909). Project A costs ₹10 lakh and yields ₹15 lakh; Project B costs ₹100 lakh and yields ₹120 lakh. Which conclusion is correct when NPV is used to maximise shareholders' wealth?
A: NPV ₹3.635 lakh and IRR 50%; B: NPV ₹9.080 lakh and IRR 20%; select B (correct answer)
A: NPV ₹5.000 lakh and IRR 50%; B: NPV ₹20.000 lakh and IRR 20%; select A
A: NPV ₹3.635 lakh and IRR 20%; B: NPV ₹9.080 lakh and IRR 50%; select A
A: NPV ₹3.635 lakh and IRR 50%; B: NPV ₹9.080 lakh and IRR 20%; select A
Answer: A — A: NPV ₹3.635 lakh and IRR 50%; B: NPV ₹9.080 lakh and IRR 20%; select B
Explanation. For A, NPV = ₹15×0.909−₹10 = ₹3.635 lakh and one-year IRR = (15÷10)−1 = 50%. For B, NPV = ₹120×0.909−₹100 = ₹9.080 lakh and IRR = (120÷100)−1 = 20%. IRR ranks the smaller project higher, but NPV measures the absolute addition to wealth. Since the projects are mutually exclusive, select B because its NPV is greater. Option d calculates both correctly but selects the lower NPV.
Where it goes wrong. Selecting the project with the higher percentage IRR despite a lower absolute NPV where project sizes differ.
Question 24 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project requires ₹4,00,000 and generates equal annual after-tax cash inflows of ₹1,00,000 over an eight-year life. Calculate the payback reciprocal and state the approximate return indicated by it.
A project requires ₹4,00,000 and generates equal annual after-tax cash inflows of ₹1,00,000 over an eight-year life. Calculate the payback reciprocal and state the approximate return indicated by it.
12.50%
20.00%
25.00% (correct answer)
40.00%
Answer: C — 25.00%
Explanation. Payback period = initial investment÷annual cash inflow = ₹4,00,000÷₹1,00,000 = 4 years. Payback reciprocal = average annual cash inflow÷initial investment×100 = ₹1,00,000÷₹4,00,000×100 = 25%. The project life of eight years is twice the payback period, satisfying the chapter's stated condition for using the reciprocal as a rough approximation of IRR when inflows are equal. Option a uses the reciprocal of project life instead.
Where it goes wrong. Dividing by useful life or confusing payback reciprocal with the annual cash-flow percentage of total project life.
Question 25 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company has a capital budget of ₹10 lakh and can accept only whole projects. The available proposals are: P - cost ₹6 lakh, NPV ₹5.0 lakh; Q - cost ₹5 lakh, NPV ₹4.5 lakh; R - cost ₹4 lakh, NPV ₹3.5 lakh; S - cost ₹4 lakh, NPV ₹3.2 lakh. Which feasible combination maximises total NPV?
A company has a capital budget of ₹10 lakh and can accept only whole projects. The available proposals are: P - cost ₹6 lakh, NPV ₹5.0 lakh; Q - cost ₹5 lakh, NPV ₹4.5 lakh; R - cost ₹4 lakh, NPV ₹3.5 lakh; S - cost ₹4 lakh, NPV ₹3.2 lakh. Which feasible combination maximises total NPV?
P + S; total NPV ₹8.2 lakh
P + R; total NPV ₹8.5 lakh (correct answer)
Q + R; total NPV ₹8.0 lakh
Q + S; total NPV ₹7.7 lakh
Answer: B — P + R; total NPV ₹8.5 lakh
Explanation. The capital budget is ₹10 lakh and projects are indivisible. P+R costs ₹6+₹4 = ₹10 lakh and produces total NPV of ₹5.0+₹3.5 = ₹8.5 lakh. P+S is also feasible at ₹10 lakh but gives ₹8.2 lakh. Q+R and Q+S give ₹8.0 lakh and ₹7.7 lakh respectively. Therefore, P+R yields the highest NPV among the feasible combinations. Ranking solely by PI would not replace checking the actual feasible combinations when projects are indivisible.
Where it goes wrong. Ranking projects by PI alone or selecting a combination that breaches the capital ceiling.
What does this Investment Decisions (Capital Budgeting) - Test 1 practice test cover?
This practice test carries 50 marks across 25 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 25 questions carrying 2 marks each, giving a maximum score of 50 marks in 60 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.
