Test 3: Investment Decisions (Capital Budgeting): answer key
This chapter-wise practice test covers Investment Decisions (Capital Budgeting) - Test 3 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 Systems Ltd. is evaluating an expansion proposal involving a specialised solar-module manufacturing line. The management expects substantial operating cash inflows from the project over its four-year useful life. The investment committee proposes evaluating the project using Discounted Payback Period and Net Present Value before taking a final investment decision.
The company currently has a capital structure comprising 60% equity and 40% long-term debt carrying an annual coupon rate of 9.50%. Its existing annual EBIT is ₹240 lakh. The applicable corporate income-tax rate is 25%. The company's estimated equity beta is 1.15, indicating the systematic risk associated with its existing equity. Treasury has already approved a post-tax WACC of 10% for this particular project. Use the approved WACC rather than recomputing the discount rate.
**Project investment and operating information (₹ lakh)**
| Particulars | Amount |
|---|---:|
| Machinery purchase price | 80 |
| Installation and commissioning | 5 |
| Initial working capital | 5 |
| Total initial investment | 90 |
| Useful life | 4 years |
| Depreciable fixed-asset cost | 85 |
| Corporate tax rate | 25% |
| Approved WACC | 10% |
**Estimated project cash flows (₹ lakh)**
| Year | Operating CFAT | Working-capital release | Total cash flow |
|---|---:|---:|---:|
| 1 | 30 | 0 | 30 |
| 2 | 40 | 0 | 40 |
| 3 | 35 | 0 | 35 |
| 4 | 25 | 5 | 30 |
**Present-value factors**
| Year | At 10% | At 15% |
|---|---:|---:|
| 1 | 0.909 | 0.870 |
| 2 | 0.826 | 0.756 |
| 3 | 0.751 | 0.658 |
| 4 | 0.683 | 0.572 |
The cash flows shown are incremental post-tax cash flows and already incorporate the applicable depreciation tax effects. The final-year cash flow includes the complete release of initial working capital. No additional capital expenditure or disposal receipt is expected. Management has also requested a sensitivity assessment at a 15% discount rate to understand the impact of a higher required return. All cash flows are assumed to occur at financial year-end.
Calculate the present value of the total Year 4 cash flow of Bharat Renewables Systems Ltd. at the approved WACC of 10%.
₹17.08 lakh
₹25.00 lakh
₹20.49 lakh (correct answer)
₹30.00 lakh
Answer: C — ₹20.49 lakh
Explanation. The Year 4 total cash flow is ₹30 lakh, comprising operating CFAT of ₹25 lakh and working-capital release of ₹5 lakh. The supplied present-value factor at 10% for Year 4 is 0.683. Therefore, PV = ₹30 lakh × 0.683 = ₹20.49 lakh. Option b discounts only the operating CFAT and omits working-capital recovery. Option d reports the undiscounted cash flow rather than its present value. Terminal-year cash flows must be discounted using their actual time period.
Where it goes wrong. Discounting only operating CFAT and forgetting the terminal working-capital release, or reporting undiscounted cash flow as present value.
Question 2 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Determine the Discounted Payback Period of the proposed manufacturing line at the approved WACC of 10%.
3.17 years (correct answer)
3.50 years
2.63 years
4.00 years
Answer: A — 3.17 years
Explanation. Discounted inflows are ₹27.27 lakh, ₹33.04 lakh, ₹26.285 lakh and ₹20.49 lakh. Cumulative PV through Year 2 = ₹60.31 lakh; through Year 3 = ₹86.595 lakh. The unrecovered amount after Year 3 is ₹90−₹86.595 = ₹3.405 lakh. Fraction of Year 4 = ₹3.405÷₹20.49 = 0.1662. Therefore, Discounted Payback Period = 3.1662 years, approximately 3.17 years. Option c is close to simple payback, not discounted payback.
Where it goes wrong. Using undiscounted cumulative cash flows or dividing the remaining amount by the undiscounted terminal-year cash flow.
Question 3 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the Net Present Value of the manufacturing line at the approved WACC of 10%.
₹20.49 lakh
₹17.09 lakh (correct answer)
₹27.09 lakh
₹107.09 lakh
Answer: B — ₹17.09 lakh
Explanation. PV of Year 1 = ₹30×0.909 = ₹27.27 lakh. PV of Year 2 = ₹40×0.826 = ₹33.04 lakh. PV of Year 3 = ₹35×0.751 = ₹26.285 lakh. PV of Year 4 = ₹30×0.683 = ₹20.49 lakh. Total PV of inflows = ₹107.085 lakh. NPV = ₹107.085−₹90 = ₹17.085 lakh, approximately ₹17.09 lakh. Option d is total PV before deducting the initial investment.
Where it goes wrong. Reporting total discounted inflows as NPV without subtracting the initial investment.
Question 4 · 2 marks · Investment Decisions (Capital Budgeting) · medium
The investment committee asks the finance department to recalculate NPV using a revised discount rate of 15%. Using the supplied present-value factors, what is the resulting NPV?
₹17.09 lakh
₹10.53 lakh
₹4.49 lakh
₹6.53 lakh (correct answer)
Answer: D — ₹6.53 lakh
Explanation. At 15%, discounted inflows are ₹30×0.870 = ₹26.10 lakh; ₹40×0.756 = ₹30.24 lakh; ₹35×0.658 = ₹23.03 lakh; and ₹30×0.572 = ₹17.16 lakh. Total PV = ₹96.53 lakh. NPV = ₹96.53−₹90 = ₹6.53 lakh. The project continues to have a positive NPV despite the higher discount rate. Option a incorrectly uses the original 10% NPV.
Where it goes wrong. Continuing to use the original discount factors after the required rate of return changes.
Question 5 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. Zenith Power Systems Ltd. manufactures industrial electrical equipment and is considering an investment in an automated assembly facility. The project is expected to improve production capacity and generate positive after-tax operating cash flows over three years. The finance department has been instructed to evaluate the investment using NPV and IRR, including interpolation between two trial discount rates.
The company's existing capital structure comprises 65% equity and 35% long-term debt. Its debt carries an annual coupon rate of 9.25%. The company has an estimated equity beta of 1.30 and current annual EBIT of ₹310 lakh. The applicable income-tax rate is 25%. The board has approved a post-tax WACC of 12% for the proposed facility. The investment appraisal must use this prescribed rate rather than independently estimating a new WACC.
**Project investment and cash-flow information (₹ lakh)**
| Particulars | Amount |
|---|---:|
| Initial machinery and installation outlay | 100 |
| Useful life | 3 years |
| Tax rate | 25% |
| Approved WACC | 12% |
**Expected incremental after-tax cash inflows (₹ lakh)**
| Year | Net cash inflow |
|---|---:|
| 1 | 60 |
| 2 | 50 |
| 3 | 40 |
**Discount factors at trial rates**
| Year | 12% | 20% | 30% |
|---|---:|---:|---:|
| 1 | 0.893 | 0.833 | 0.769 |
| 2 | 0.797 | 0.694 | 0.592 |
| 3 | 0.712 | 0.579 | 0.455 |
The cash inflows are incremental project cash flows after operating costs, depreciation tax effects and corporate income tax. They exclude interest and dividend payments. There are no further capital investments, working-capital injections, salvage proceeds or terminal adjustments. The company assumes that all annual cash inflows are received at the end of their respective years. The board wishes to understand both the absolute addition to shareholders' wealth and the percentage return earned on the initial investment. For IRR interpolation, use the supplied discount factors and retain two decimal places in the final percentage.
Calculate the NPV of Zenith Power Systems Ltd.'s proposed assembly facility using its approved WACC of 12%.
₹25.88 lakh
₹18.91 lakh
₹21.91 lakh (correct answer)
₹31.91 lakh
Answer: C — ₹21.91 lakh
Explanation. PV of Year 1 inflow = ₹60×0.893 = ₹53.58 lakh. PV of Year 2 = ₹50×0.797 = ₹39.85 lakh. PV of Year 3 = ₹40×0.712 = ₹28.48 lakh. Total PV of inflows = ₹121.91 lakh. NPV = ₹121.91−₹100 = ₹21.91 lakh. Since NPV is positive, the investment is financially acceptable under the NPV criterion. Option a uses incorrect discount factors or arithmetic.
Where it goes wrong. Using undiscounted cash flows or deducting the initial investment incorrectly when calculating NPV.
Question 7 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Based on the estimated IRR and the approved WACC, determine the appropriate investment decision for Zenith Power Systems Ltd.
Reject, because IRR is lower than 30%.
Reject, because IRR is lower than the Year 1 cash-flow percentage.
Accept, because the initial investment is recovered within three years.
Accept, because estimated IRR exceeds the approved WACC. (correct answer)
Answer: D — Accept, because estimated IRR exceeds the approved WACC.
Explanation. The estimated IRR is approximately 25.64%, whereas the approved post-tax WACC is 12%. Under the IRR decision rule, a project is acceptable when its IRR exceeds the required rate of return or cost of capital. Since 25.64% exceeds 12%, Zenith should accept the project. The comparison is with the approved required return, not an arbitrary trial rate such as 30%. Positive NPV at 12% independently supports the same conclusion.
Where it goes wrong. Comparing estimated IRR with an arbitrary trial rate instead of the approved cost of capital.
Question 8 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Assuming the project's estimated IRR of 25.64% is the reinvestment rate, calculate the future value at the end of Year 3 of the ₹60 lakh received at the end of Year 1.
₹75.38 lakh
₹94.71 lakh (correct answer)
₹85.64 lakh
₹60.00 lakh
Answer: B — ₹94.71 lakh
Explanation. Under the conventional IRR reinvestment assumption, interim cash inflows are reinvested at the project's IRR. The Year 1 inflow of ₹60 lakh has two years remaining until the end of Year 3. Future value = ₹60 lakh×(1.2564)² = ₹60 lakh×1.57854 = ₹94.7124 lakh, approximately ₹94.71 lakh. Option d ignores reinvestment, while option a uses only one year's compounding.
Where it goes wrong. Compounding an intermediate cash inflow for only one year instead of the two remaining years.
Question 9 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Aditya Automotive Ltd. manufactures specialised automotive transmission components. The company is considering two mutually exclusive production automation proposals. Both alternatives require the same initial investment, but their expected cash-flow timings differ considerably. Project A generates a substantial cash inflow immediately, whereas Project B produces its major cash inflow towards the end of its evaluation period. The investment committee wants to understand whether NPV and IRR will necessarily produce the same ranking.
The company has an existing capital structure of 55% equity and 45% long-term debt. Its term debt carries an annual coupon of 9.50%. The company's equity beta is estimated at 1.20, and its current annual EBIT is ₹420 lakh. The corporate income-tax rate is 25%. The approved post-tax WACC for both proposed investments is 10%. The beta and debt information is provided for corporate risk context; the approved WACC is the relevant discount rate for the project appraisal.
**Investment and projected cash flows (₹ lakh)**
| Particulars | Project A | Project B |
|---|---:|---:|
| Initial investment (Year 0) | 100 | 100 |
| Year 1 inflow | 120 | 0 |
| Year 2 inflow | 0 | 0 |
| Year 3 inflow | 0 | 160 |
| Useful evaluation life | 3 years | 3 years |
**Present-value factors at 10%**
| Year | Discount factor |
|---|---:|
| 1 | 0.909 |
| 2 | 0.826 |
| 3 | 0.751 |
Both projects are independent of the company's existing operating cash flows, and the stated inflows are already after-tax incremental project cash flows. There are no additional investment requirements, salvage proceeds or working-capital adjustments. All inflows occur at year-end. The projects are mutually exclusive, meaning acceptance of one proposal automatically rules out the other. The board's primary objective is to maximise shareholders' wealth, but it also wishes to examine the rankings produced by IRR. The committee has specifically requested that the analysis distinguish between the percentage return and the absolute monetary addition created by each alternative.
Calculate the NPVs of Project A and Project B at 10% and identify the project generating the greater addition to shareholders' wealth.
Question 10 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the IRR of both mutually exclusive projects and determine which alternative is ranked higher under the IRR method.
A: 16.96%; B: 20.00%; select B.
A: 30.00%; B: 25.00%; select A.
A: 20.00%; B: 16.96%; select A. (correct answer)
A: 20.00%; B: 25.00%; select B.
Answer: C — A: 20.00%; B: 16.96%; select A.
Explanation. Project A produces ₹120 lakh after one year on an investment of ₹100 lakh. IRR = (120÷100)−1 = 20%. For Project B, ₹160 lakh is received after three years. Therefore, 100 = 160÷(1+r)³. Hence, (1+r)³ = 1.60 and r = (1.60)^(1/3)−1 = 16.96% approximately. Project A has the higher IRR. The higher percentage return does not automatically establish the higher NPV.
Where it goes wrong. Treating a three-year terminal inflow as though it were received after one year.
Question 11 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Which project should be ranked higher when the IRR method alone is used for the two mutually exclusive proposals?
Project B, because it generates a higher terminal cash inflow.
Project A, because its IRR is approximately 20%, compared with 16.96% for Project B. (correct answer)
Project B, because its NPV is higher.
Both projects, because they require identical initial investment.
Answer: B — Project A, because its IRR is approximately 20%, compared with 16.96% for Project B.
Explanation. Project A earns ₹20 lakh over its one-year investment period, producing an IRR of 20%. Project B produces ₹160 lakh after three years on an initial investment of ₹100 lakh, giving an annualised IRR of approximately 16.96%. Therefore, the IRR method ranks Project A higher. Project B's superior NPV is a different ranking criterion and must not be substituted when the question specifically asks for the IRR ranking.
Where it goes wrong. Confusing the ranking under NPV with the ranking under IRR.
Question 12 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Why do NPV and IRR produce different rankings for Projects A and B, and which method should guide selection when the objective is maximisation of shareholders' wealth?
The difference arises because NPV ignores the timing of cash flows; IRR should always prevail.
The difference arises because both methods assume reinvestment at WACC; therefore either project can be selected.
The difference arises because NPV considers only the initial investment; IRR considers all future cash flows.
Different cash-flow timing and reinvestment assumptions can create conflicting rankings; NPV should guide the wealth-maximising decision, favouring Project B. (correct answer)
Answer: D — Different cash-flow timing and reinvestment assumptions can create conflicting rankings; NPV should guide the wealth-maximising decision, favouring Project B.
Explanation. Project A produces an earlier cash inflow and a higher IRR of 20%, whereas Project B has a lower IRR of 16.96% but a higher NPV of ₹20.16 lakh against ₹9.08 lakh for A. NPV assumes reinvestment at the cost of capital, whereas IRR assumes reinvestment at IRR. With mutually exclusive alternatives, NPV measures absolute wealth addition and should guide the decision. Project B is therefore preferred.
Where it goes wrong. Treating IRR's higher percentage return as conclusive despite a higher NPV from the competing mutually exclusive project.
Question 13 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A manufacturing project requires an initial cash outflow of ₹80,000 and generates after-tax cash inflows of ₹40,000, ₹40,000 and ₹30,000 in Years 1, 2 and 3 respectively. The discount rate is 10%. Using PV factors of 0.909, 0.826 and 0.751, calculate its Discounted Payback Period.
A manufacturing project requires an initial cash outflow of ₹80,000 and generates after-tax cash inflows of ₹40,000, ₹40,000 and ₹30,000 in Years 1, 2 and 3 respectively. The discount rate is 10%. Using PV factors of 0.909, 0.826 and 0.751, calculate its Discounted Payback Period.
2.00 years
2.35 years
2.47 years (correct answer)
3.00 years
Answer: C — 2.47 years
Explanation. Discounted inflows are ₹36,360, ₹33,040 and ₹22,530. Cumulative discounted inflow after Year 2 = ₹69,400. Unrecovered outlay = ₹80,000−₹69,400 = ₹10,600. Fraction of Year 3 = ₹10,600÷₹22,530 = 0.4705. Discounted Payback Period = 2+0.4705 = 2.47 years approximately. Option b is not the result of the correct discounted cumulative recovery calculation.
Where it goes wrong. Using simple cash inflows instead of discounted cash inflows when determining the payback period.
Question 14 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project requires an initial investment of ₹1,00,000 and generates uniform annual cash inflows of ₹35,000 for three years. At a discount rate of 10%, the present-value factors are 0.909, 0.826 and 0.751. Determine the correct discounted-payback conclusion.
A project requires an initial investment of ₹1,00,000 and generates uniform annual cash inflows of ₹35,000 for three years. At a discount rate of 10%, the present-value factors are 0.909, 0.826 and 0.751. Determine the correct discounted-payback conclusion.
The discounted investment is not recovered within the three-year useful life. (correct answer)
The discounted payback period is exactly 3 years.
The discounted payback period is 2.87 years.
The discounted payback period is 2.50 years.
Answer: A — The discounted investment is not recovered within the three-year useful life.
Explanation. PV of Year 1 = ₹35,000×0.909 = ₹31,815. PV of Year 2 = ₹35,000×0.826 = ₹28,910. PV of Year 3 = ₹35,000×0.751 = ₹26,285. Total discounted inflows = ₹87,010. This is less than the initial investment of ₹1,00,000, leaving ₹12,990 unrecovered. Therefore, discounted payback is not achieved during the three-year useful life. Option b assumes recovery merely because three years have elapsed.
Where it goes wrong. Assuming that the project achieves discounted payback automatically at the end of its stated useful life.
Question 15 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project requires an initial outlay of ₹1,50,000. It generates ₹70,000 at the end of Year 1 and operating cash flow of ₹80,000 in Year 2. At the end of Year 2, it additionally receives salvage proceeds of ₹20,000 and working-capital release of ₹10,000. Calculate NPV at 10%, using factors 0.909 and 0.826.
A project requires an initial outlay of ₹1,50,000. It generates ₹70,000 at the end of Year 1 and operating cash flow of ₹80,000 in Year 2. At the end of Year 2, it additionally receives salvage proceeds of ₹20,000 and working-capital release of ₹10,000. Calculate NPV at 10%, using factors 0.909 and 0.826.
₹1,50,000
₹10,490
(₹4,490)
₹4,490 (correct answer)
Answer: D — ₹4,490
Explanation. Year 1 PV = ₹70,000×0.909 = ₹63,630. Total Year 2 cash flow = ₹80,000+₹20,000+₹10,000 = ₹1,10,000. Its PV = ₹1,10,000×0.826 = ₹90,860. Total PV of inflows = ₹1,54,490. NPV = ₹1,54,490−₹1,50,000 = ₹4,490. The salvage proceeds and working-capital release must be included in the terminal cash flow.
Where it goes wrong. Omitting terminal receipts or deducting the initial outflow twice when calculating NPV.
Question 16 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project produces cash inflows of ₹40,000 at the end of Year 1, ₹50,000 at the end of Year 2 and ₹60,000 at the end of Year 3. Using the NPV method's reinvestment assumption and a cost of capital of 10%, calculate the terminal value of these cash inflows at the end of Year 3.
A project produces cash inflows of ₹40,000 at the end of Year 1, ₹50,000 at the end of Year 2 and ₹60,000 at the end of Year 3. Using the NPV method's reinvestment assumption and a cost of capital of 10%, calculate the terminal value of these cash inflows at the end of Year 3.
₹1,50,000
₹1,63,400 (correct answer)
₹1,65,000
₹1,73,400
Answer: B — ₹1,63,400
Explanation. Under the NPV reinvestment assumption, interim cash inflows are reinvested at the discount rate, here 10%. Year 1 inflow grows for two years: ₹40,000×1.21 = ₹48,400. Year 2 grows for one year: ₹50,000×1.10 = ₹55,000. Year 3 remains ₹60,000. Total terminal value = ₹48,400+₹55,000+₹60,000 = ₹1,63,400. The Year 3 inflow is not compounded.
Where it goes wrong. Compounding all cash flows for an identical number of years instead of using their respective remaining investment periods.
Question 17 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project requires an initial investment of ₹1,00,000 and generates inflows of ₹70,000 and ₹50,000 at the ends of Years 1 and 2. Calculate NPV at 10% and 15%, using factors of 0.909 and 0.826 at 10%, and 0.870 and 0.756 at 15%. Which conclusion is correct?
A project requires an initial investment of ₹1,00,000 and generates inflows of ₹70,000 and ₹50,000 at the ends of Years 1 and 2. Calculate NPV at 10% and 15%, using factors of 0.909 and 0.826 at 10%, and 0.870 and 0.756 at 15%. Which conclusion is correct?
NPV at 10% is +₹4,930 and at 15% is −₹1,300; accept at 10% but reject at 15%. (correct answer)
NPV at both rates is positive; accept under either discount rate.
NPV at 10% is −₹4,930 and at 15% is +₹1,300; accept only at 15%.
NPV at both rates is negative; reject under either discount rate.
Answer: A — NPV at 10% is +₹4,930 and at 15% is −₹1,300; accept at 10% but reject at 15%.
Explanation. At 10%, PV = ₹70,000×0.909 + ₹50,000×0.826 = ₹63,630+₹41,300 = ₹1,04,930. NPV = +₹4,930. At 15%, PV = ₹70,000×0.870 + ₹50,000×0.756 = ₹60,900+₹37,800 = ₹98,700. NPV = −₹1,300. The project is acceptable at 10% but not at 15%. A higher discount rate reduces the present value of future inflows.
Where it goes wrong. Assuming that NPV remains unchanged when the required discount rate changes.
Question 18 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. An investment of ₹5,00,000 generates a single cash inflow of ₹6,25,000 exactly one year after investment. Calculate the IRR.
An investment of ₹5,00,000 generates a single cash inflow of ₹6,25,000 exactly one year after investment. Calculate the IRR.
20%
30%
25% (correct answer)
15%
Answer: C — 25%
Explanation. IRR is the discount rate that equates the present value of the future cash inflow with the initial investment. Therefore, ₹5,00,000 = ₹6,25,000÷(1+r). Thus, 1+r = ₹6,25,000÷₹5,00,000 = 1.25. Consequently, r = 1.25−1 = 25%. Option b incorrectly treats the absolute increase of ₹1,25,000 as 30% of the original investment.
Where it goes wrong. Calculating the percentage increase using the wrong denominator or treating the cash-flow difference as the IRR.
Question 19 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. An enterprise invests ₹10,00,000 in a project that produces a single cash inflow of ₹14,40,000 at the end of Year 2. There are no interim cash inflows. Calculate the project's IRR.
An enterprise invests ₹10,00,000 in a project that produces a single cash inflow of ₹14,40,000 at the end of Year 2. There are no interim cash inflows. Calculate the project's IRR.
15%
18%
22%
20% (correct answer)
Answer: D — 20%
Explanation. The IRR equation is ₹10,00,000 = ₹14,40,000÷(1+r)². Rearranging gives (1+r)² = ₹14,40,000÷₹10,00,000 = 1.44. Taking the square root, 1+r = 1.20. Therefore, r = 20%. The cash inflow occurs after two years, so the annualised rate must be calculated using the square root rather than treating the entire ₹4,40,000 increase as a one-year return.
Where it goes wrong. Ignoring the two-year holding period and calculating the cumulative percentage gain as an annual return.
Question 20 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project produces an NPV of +₹18 lakh at a trial discount rate of 12% and an NPV of −₹2 lakh at a trial discount rate of 16%. Estimate IRR using the interpolation method.
A project produces an NPV of +₹18 lakh at a trial discount rate of 12% and an NPV of −₹2 lakh at a trial discount rate of 16%. Estimate IRR using the interpolation method.
14.40%
15.60% (correct answer)
13.20%
16.00%
Answer: B — 15.60%
Explanation. Using the interpolation formula: IRR = L + [NPV at L÷(NPV at L−NPV at H)]×(H−L). Substituting: IRR = 12%+[18÷(18−(−2))]×(16%−12%). Therefore, IRR = 12%+(18÷20)×4% = 12%+3.60% = 15.60%. The high-rate NPV is negative and must be included with its negative sign in the denominator calculation.
Where it goes wrong. Failing to account for the negative sign of the higher-rate NPV when computing the interpolation denominator.
Question 21 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company invests ₹2,00,000 in a project and expects equal annual cash inflows of ₹80,000 for three years. At 8%, the three-year annuity factor is 2.577, and at 10%, it is 2.487. Estimate the IRR by interpolation.
A company invests ₹2,00,000 in a project and expects equal annual cash inflows of ₹80,000 for three years. At 8%, the three-year annuity factor is 2.577, and at 10%, it is 2.487. Estimate the IRR by interpolation.
9.71% (correct answer)
8.86%
10.29%
12.00%
Answer: A — 9.71%
Explanation. At 8%, PV of inflows = ₹80,000×2.577 = ₹2,06,160, giving NPV of +₹6,160. At 10%, PV = ₹80,000×2.487 = ₹1,98,960, giving NPV of −₹1,040. IRR = 8%+[6,160÷(6,160+1,040)]×2% = 8%+(6,160÷7,200)×2% = 9.71% approximately. The IRR lies between the trial rates because NPV changes from positive to negative.
Where it goes wrong. Using the full NPV difference as the interpolation numerator instead of the positive NPV.
Question 22 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Two mutually exclusive projects are available to a company having a cost of capital of 10% (PV factor for one year: 0.909).
| Particulars | Project A | Project B |
|---|---:|---:|
| Initial investment | ₹20 lakh | ₹100 lakh |
| Year 1 cash inflow | ₹30 lakh | ₹130 lakh |
Calculate their respective NPV and IRR rankings. Which alternative should be preferred under the NPV criterion?
Two mutually exclusive projects are available to a company having a cost of capital of 10% (PV factor for one year: 0.909).
| Particulars | Project A | Project B |
|---|---:|---:|
| Initial investment | ₹20 lakh | ₹100 lakh |
| Year 1 cash inflow | ₹30 lakh | ₹130 lakh |
Calculate their respective NPV and IRR rankings. Which alternative should be preferred under the NPV criterion?
Answer: C — A: NPV ₹7.27 lakh, IRR 50%; B: NPV ₹18.17 lakh, IRR 30%; select B.
Explanation. Project A: NPV = ₹30×0.909−₹20 = ₹7.27 lakh; IRR = (30÷20−1)×100 = 50%. Project B: NPV = ₹130×0.909−₹100 = ₹18.17 lakh; IRR = (130÷100−1)×100 = 30%. IRR ranks A higher because it is a relative percentage measure. NPV ranks B higher because it generates the larger absolute wealth addition. For mutually exclusive projects, NPV should guide the wealth-maximising selection.
Where it goes wrong. Selecting the smaller project merely because its percentage IRR is higher, ignoring the difference in project scale.
Question 23 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Two mutually exclusive investment proposals each require an initial investment of ₹50 lakh. The cost of capital is 10%.
| Year | Project A | Project B |
|---|---:|---:|
| 1 | ₹80 lakh | Nil |
| 2 | Nil | Nil |
| 3 | Nil | ₹125 lakh |
The respective discount factors are 0.909 for Year 1 and 0.751 for Year 3. Which conclusion correctly demonstrates a conflict between NPV and IRR?
Two mutually exclusive investment proposals each require an initial investment of ₹50 lakh. The cost of capital is 10%.
| Year | Project A | Project B |
|---|---:|---:|
| 1 | ₹80 lakh | Nil |
| 2 | Nil | Nil |
| 3 | Nil | ₹125 lakh |
The respective discount factors are 0.909 for Year 1 and 0.751 for Year 3. Which conclusion correctly demonstrates a conflict between NPV and IRR?
NPV prefers A, while IRR prefers B.
Both methods prefer A.
Both methods prefer B.
NPV prefers B with approximately ₹43.88 lakh, while IRR prefers A with 60%. (correct answer)
Answer: D — NPV prefers B with approximately ₹43.88 lakh, while IRR prefers A with 60%.
Explanation. Project A NPV = ₹80×0.909−₹50 = ₹22.72 lakh; IRR = (80÷50−1)×100 = 60%. Project B NPV = ₹125×0.751−₹50 = ₹43.875 lakh. Its IRR satisfies 50(1+r)³ = 125, giving r = (2.5)^(1/3)−1 = 35.72% approximately. Therefore, NPV prefers B, while IRR prefers A. The different timing of the cash inflows produces conflicting rankings.
Where it goes wrong. Ignoring the different timing of cash flows and assuming the higher IRR must correspond to the higher NPV.
Question 24 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Two mutually exclusive projects have different useful lives. The approved cost of capital is 10%.
| Particulars | Project A | Project B |
|---|---:|---:|
| Initial outflow | ₹100 lakh | ₹100 lakh |
| Useful life | 1 year | 3 years |
| Terminal cash inflow | ₹130 lakh in Year 1 | ₹160 lakh in Year 3 |
Use PV factors of 0.909 for Year 1 and 0.751 for Year 3. Which statement correctly identifies the ranking conflict?
Two mutually exclusive projects have different useful lives. The approved cost of capital is 10%.
| Particulars | Project A | Project B |
|---|---:|---:|
| Initial outflow | ₹100 lakh | ₹100 lakh |
| Useful life | 1 year | 3 years |
| Terminal cash inflow | ₹130 lakh in Year 1 | ₹160 lakh in Year 3 |
Use PV factors of 0.909 for Year 1 and 0.751 for Year 3. Which statement correctly identifies the ranking conflict?
Both NPV and IRR prefer Project B.
NPV prefers Project B, while IRR prefers Project A. (correct answer)
NPV prefers Project A, while IRR prefers Project B.
Both NPV and IRR prefer Project A.
Answer: B — NPV prefers Project B, while IRR prefers Project A.
Explanation. Project A NPV = ₹130×0.909−₹100 = ₹18.17 lakh; its IRR is 130÷100−1 = 30%. Project B NPV = ₹160×0.751−₹100 = ₹20.16 lakh. Its IRR is (1.60)^(1/3)−1 = 16.96% approximately. Thus, NPV prefers B because of its greater absolute wealth addition, while IRR prefers A because of its higher annual percentage return. The projects also have unequal useful lives.
Where it goes wrong. Comparing the total cash inflow of projects with unequal useful lives without considering annualised return and discounted value.
Question 25 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project has an estimated IRR of 15%. It generates an interim cash inflow of ₹50,000 at the end of Year 1. Assuming reinvestment at the IRR, calculate the future value of this inflow at the end of Year 3.
A project has an estimated IRR of 15%. It generates an interim cash inflow of ₹50,000 at the end of Year 1. Assuming reinvestment at the IRR, calculate the future value of this inflow at the end of Year 3.
₹66,125 (correct answer)
₹57,500
₹60,000
₹76,125
Answer: A — ₹66,125
Explanation. Under the conventional IRR reinvestment assumption, interim cash inflows are reinvested at the project's IRR of 15%. The Year 1 inflow has two years remaining before the end of Year 3. Future value = ₹50,000×(1.15)² = ₹50,000×1.3225 = ₹66,125. Option b compounds for only one year. Option c assumes no reinvestment, while option d applies an incorrect compounding period or rate.
Where it goes wrong. Using the cost of capital instead of IRR, or incorrectly calculating the number of compounding periods.
What does this Investment Decisions (Capital Budgeting) - Test 3 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.
