Test 4: Investment Decisions (Capital Budgeting): answer key
This chapter-wise practice test covers Investment Decisions (Capital Budgeting) - Test 4 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. manufactures solar panels, inverters and energy-storage components. The company is evaluating three independent expansion proposals to increase its manufacturing capacity. However, due to a restriction on funds available for capital expenditure, the board cannot undertake every proposal simultaneously. The finance director has recommended using Profitability Index (PI) to prioritise investments and subsequently examining feasible project combinations to maximise total shareholder wealth.
The company currently has a capital structure comprising 60% equity and 40% long-term debt. Its term loan carries an annual coupon rate of 9.50%. The existing annual EBIT is ₹240 lakh, the applicable corporate tax rate is 25%, and the estimated equity beta is 1.15. The approved post-tax WACC for the expansion proposals is 10%. The company operates with an average working-capital cycle of 50 days. All cash flows supplied below are incremental after-tax cash flows.
**Investment appraisal information (₹ lakh)**
| Particulars | Project A | Project B | Project C |
|---|---:|---:|---:|
| Initial cash outlay | 60 | 40 | 50 |
| PV of all expected cash inflows | 78 | 50 | 61 |
| NPV | 18 | 10 | 11 |
| Project life | 4 years | 4 years | 4 years |
| Discount rate | 10% | 10% | 10% |
**Capital availability:** ₹100 lakh.
The present values shown above have been calculated from the complete annual project cash-flow forecasts using the approved WACC. The proposals are indivisible, independent and can be undertaken individually or in permitted combinations. There are no technical dependencies between projects. Each project requires its stated initial investment at the beginning of the investment period. The company will not accept a combination exceeding its ₹100 lakh capital ceiling. The investment committee requires both relative profitability and absolute NPV to be considered. The board has specifically cautioned that a higher PI does not necessarily mean a project or project portfolio will produce the maximum total NPV under indivisible capital rationing.
Calculate the Profitability Index of Project C.
1.10 times
1.50 times
1.22 times (correct answer)
0.82 times
Answer: C — 1.22 times
Explanation. Profitability Index = Present Value of Cash Inflows ÷ Initial Cash Outlay. For Project C, PI = ₹61 lakh ÷ ₹50 lakh = 1.22 times. Since PI exceeds 1, the project is acceptable when considered independently. Option a incorrectly uses NPV divided by initial investment, while option d reverses the numerator and denominator. The PI measures the present value generated per rupee of initial investment.
Where it goes wrong. Using NPV instead of total PV of inflows in the numerator or reversing the PI formula.
Question 2 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Determine the correct ranking of the three proposals according to their Profitability Index.
A, B, C (correct answer)
C, A, B
B, C, A
A, C, B
Answer: A — A, B, C
Explanation. Project A PI = 78÷60 = 1.30. Project B PI = 50÷40 = 1.25. Project C PI = 61÷50 = 1.22. Therefore, the descending ranking is A, B, C. The PI identifies relative profitability rather than the absolute amount of wealth created. Project C's NPV of ₹11 lakh does not make its PI greater than Project B's PI of 1.25. Hence, option a is correct.
Where it goes wrong. Ranking projects using absolute NPV or total cash inflows instead of their respective profitability indices.
Question 3 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Considering the ₹100 lakh capital ceiling and the indivisibility of the proposals, which combination maximises the total NPV?
Projects B and C, total NPV ₹21 lakh
Projects A and C, total NPV ₹29 lakh
Project A alone, total NPV ₹18 lakh
Projects A and B, total NPV ₹28 lakh (correct answer)
Answer: D — Projects A and B, total NPV ₹28 lakh
Explanation. Project A and B together require ₹60 + ₹40 = ₹100 lakh and generate total NPV of ₹18 + ₹10 = ₹28 lakh. B and C cost ₹90 lakh and generate ₹21 lakh NPV. A and C require ₹110 lakh and exceed the budget. Individual projects generate NPVs of ₹18 lakh, ₹10 lakh and ₹11 lakh respectively. Therefore, A and B produce the greatest NPV among feasible combinations. Option b is infeasible.
Where it goes wrong. Ignoring the capital ceiling or selecting projects solely by individual PI without testing feasible combinations.
Question 4 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Calculate the combined Profitability Index of the selected portfolio comprising Projects A and B.
1.22 times
1.28 times (correct answer)
1.30 times
1.50 times
Answer: B — 1.28 times
Explanation. Combined initial outlay = ₹60 + ₹40 = ₹100 lakh. Combined PV of cash inflows = ₹78 + ₹50 = ₹128 lakh. Therefore, portfolio PI = ₹128÷₹100 = 1.28 times. The combined portfolio PI is calculated from aggregate present values and aggregate investment, not by taking a simple arithmetic average of the individual PIs. Option c incorrectly reports the highest individual PI rather than the combined portfolio measure.
Where it goes wrong. Taking the arithmetic average of individual PIs rather than dividing aggregate PV of inflows by aggregate investment.
Question 5 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. Zenith Power Systems Ltd. manufactures electrical equipment and industrial power-control systems. It is evaluating a four-year automation project involving an initial investment and a subsequent major maintenance-related capital expenditure. Since the project has both positive and negative cash flows after commencement, the finance department has proposed using Modified Internal Rate of Return (MIRR) instead of relying exclusively on conventional IRR.
The company's capital structure comprises 65% equity and 35% long-term debt. Its term debt carries an annual coupon rate of 9%. Existing annual EBIT is ₹310 lakh and the applicable corporate tax rate is 25%. The estimated equity beta is 1.30. The board has approved a post-tax WACC of 10% for the project. The company's average working-capital operating cycle is 60 days.
**Project cash-flow estimates (₹ lakh)**
| Year | Project cash flow |
|---:|---:|
| 0 | (100) |
| 1 | 35 |
| 2 | (20) |
| 3 | 50 |
| 4 | 80 |
The cash flows are incremental and after tax, with financing costs excluded from the operating cash-flow estimates. The Year 2 negative cash flow represents an additional unavoidable project capital requirement. There are no further cash flows after Year 4. The finance department has separately established a financing rate of 8% for discounting subsequent negative cash flows and a reinvestment rate of 12% for accumulating positive cash inflows to the terminal year. For the two-rate MIRR questions in this test, the initial investment is taken at Year 0 without discounting, subsequent negative cash flows are discounted to Year 0 at the financing rate, and positive cash flows are compounded to Year 4 at the reinvestment rate. The resulting terminal value and present value of investment are used to determine MIRR over the complete four-year period. This two-rate formulation is the specific method prescribed for the case.
Calculate the present value of all negative cash flows of Zenith Power Systems Ltd.'s project using the prescribed financing rate of 8%. Use a two-year present-value factor of 0.8573.
₹117.15 lakh (correct answer)
₹120.00 lakh
₹102.85 lakh
₹137.15 lakh
Answer: A — ₹117.15 lakh
Explanation. The Year 0 initial outflow is ₹100 lakh. The additional Year 2 outflow of ₹20 lakh must be discounted at the financing rate of 8%. Its present value is ₹20×0.8573 = ₹17.146 lakh. Total present value of negative cash flows = ₹100 + ₹17.146 = ₹117.146 lakh, approximately ₹117.15 lakh. Option b ignores the time value of the additional Year 2 capital requirement.
Where it goes wrong. Discounting an additional future negative cash flow at the reinvestment rate or including it at its undiscounted amount.
Question 6 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the terminal value of all positive cash flows at the end of Year 4 using the reinvestment rate of 12%.
₹165.17 lakh
₹178.15 lakh
₹185.17 lakh (correct answer)
₹205.17 lakh
Answer: C — ₹185.17 lakh
Explanation. Year 1 inflow grows for three years: ₹35×1.12³ = ₹49.17248 lakh. Year 3 inflow grows for one year: ₹50×1.12 = ₹56 lakh. The Year 4 inflow of ₹80 lakh is already at the terminal date. Therefore, terminal value = ₹49.17248 + ₹56 + ₹80 = ₹185.17248 lakh, approximately ₹185.17 lakh. Compounding every inflow for four years would be incorrect because the receipt dates differ.
Where it goes wrong. Applying the same compounding period to every cash inflow instead of calculating the remaining years until the terminal date.
Question 7 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the Modified Internal Rate of Return (MIRR) of the project using the prescribed financing and reinvestment rates.
10.00%
12.13% (correct answer)
15.50%
18.25%
Answer: B — 12.13%
Explanation. Present value of negative cash flows = ₹117.14678 lakh. Terminal value of positive cash flows = ₹185.17248 lakh. MIRR = (Terminal Value÷PV of Negative Cash Flows)^(1/n)−1. Therefore, MIRR = (185.17248÷117.14678)^(1/4)−1 = 12.13% approximately. The exponent is 1/4 because the investment period is four years. The financing rate and reinvestment rate are applied to their respective cash-flow categories.
Where it goes wrong. Using the reinvestment rate as MIRR directly or calculating MIRR without discounting the subsequent negative cash flow.
Question 8 · 2 marks · Investment Decisions (Capital Budgeting) · hard
If the company's minimum acceptable return is its approved WACC of 10%, what is the appropriate investment decision based on the calculated MIRR?
Reject, because MIRR is lower than the reinvestment rate.
Reject, because MIRR is greater than the financing rate.
Accept, because the terminal value exceeds the initial investment.
Accept, because MIRR exceeds the required rate of return. (correct answer)
Answer: D — Accept, because MIRR exceeds the required rate of return.
Explanation. The project's calculated MIRR is approximately 12.13%, and its approved WACC is 10%. Under the MIRR decision criterion, accept the proposal when MIRR exceeds the required rate of return. Since 12.13% > 10%, the investment should be accepted. The financing rate and reinvestment rate are calculation inputs, not independent acceptance thresholds. Option c is insufficient because a terminal value greater than initial investment does not by itself establish an acceptable annualised return.
Where it goes wrong. Comparing MIRR with the reinvestment rate instead of the company's minimum required return or WACC.
Question 9 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. Aditya Automotive Ltd. manufactures automotive transmission systems and precision components. The company is assessing an expansion proposal whose operating estimates have been prepared in constant purchasing-power terms. Since inflation is expected to affect material costs, selling prices, labour expenses and future operating receipts, the investment committee wants the project evaluated consistently using either real cash flows with a real discount rate or nominal cash flows with a nominal discount rate.
The company has a capital structure comprising 55% equity and 45% long-term debt carrying a coupon rate of 9.50%. Its current annual EBIT is ₹420 lakh. The applicable corporate income-tax rate is 25%, and the estimated equity beta is 1.20. The board has approved a real required return of 10% and the finance department forecasts annual inflation of 5%. The company normally maintains a 60-day operating working-capital cycle.
**Project investment and cash-flow estimates (₹ lakh)**
| Particulars | Amount |
|---|---:|
| Initial investment, including working capital | 100 |
| Year 1 real after-tax cash inflow | 40 |
| Year 2 real after-tax cash inflow | 50 |
| Year 3 real after-tax cash inflow | 60 |
| Annual inflation | 5% |
| Real required return | 10% |
| Project life | 3 years |
The estimated cash inflows are incremental after-tax cash flows expressed in today's purchasing power. They include the relevant operating-cycle adjustments and the terminal working-capital release. For the purpose of inflation adjustment, assume each real cash inflow increases at the stated annual inflation rate, compounded annually. The initial investment occurs immediately and is not inflated. The finance team has been instructed to use the Fisher relationship: (1 + nominal rate) = (1 + real rate) × (1 + inflation rate). All project cash flows occur at year-end. The investment committee will compare the real and nominal valuation approaches and reject calculations that mix nominal cash flows with a real discount rate or real cash flows with a nominal discount rate. The purpose is to ensure that the calculated NPV correctly reflects the project's economic value without double-counting or ignoring inflation.
Calculate the nominal required rate of return for Aditya Automotive Ltd. using the Fisher relationship.
14.50%
15.50% (correct answer)
10.50%
16.00%
Answer: B — 15.50%
Explanation. Fisher relationship: (1 + nominal rate) = (1 + real rate)(1 + inflation rate). Substituting: (1 + nominal rate) = 1.10×1.05 = 1.155. Therefore, nominal rate = 1.155−1 = 15.50%. The inflation adjustment must be compounded with the real return. Simply adding 10% and 5% produces the incorrect approximation of 15% and ignores the interaction between the two rates.
Where it goes wrong. Adding the real required return and inflation rate arithmetically instead of applying the precise Fisher relationship.
Question 10 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the Year 3 nominal cash inflow corresponding to the real cash inflow of ₹60 lakh expressed in today's purchasing power.
₹63.00 lakh
₹69.00 lakh
₹66.15 lakh
₹69.46 lakh (correct answer)
Answer: D — ₹69.46 lakh
Explanation. Nominal cash flow = Real cash flow×(1+Inflation rate)^n. For Year 3, nominal cash inflow = ₹60 lakh×(1.05)³ = ₹60 lakh×1.157625 = ₹69.4575 lakh, approximately ₹69.46 lakh. Inflation is compounded for three years because the cash flow is received at the end of Year 3. Applying only two years of inflation would understate the nominal amount.
Where it goes wrong. Applying inflation for one year less or using simple inflation addition instead of annual compounding.
Question 11 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the project's NPV using the real cash flows and the real required return of 10%.
₹18.76 lakh
₹25.50 lakh
₹22.76 lakh (correct answer)
₹32.76 lakh
Answer: C — ₹22.76 lakh
Explanation. NPV = 40/1.10 + 50/(1.10)² + 60/(1.10)³ − 100. The respective present values are ₹36.3636 lakh, ₹41.3223 lakh and ₹45.0789 lakh. Total PV of inflows = ₹122.7648 lakh. NPV = ₹122.7648−₹100 = ₹22.7648 lakh, approximately ₹22.76 lakh. Real cash flows must be discounted at the real required return, without adding inflation again.
Where it goes wrong. Inflating constant-purchasing-power cash flows again before discounting them at a real rate.
Question 12 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Which NPV should be obtained when the finance department converts all three real cash inflows into nominal cash inflows and discounts them using the correctly calculated nominal required return?
Approximately ₹22.76 lakh, identical to the real-cash-flow method. (correct answer)
Approximately ₹27.76 lakh, higher than the real-cash-flow method.
Approximately ₹18.76 lakh, lower than the real-cash-flow method.
Approximately ₹32.76 lakh, higher due to annual inflation.
Answer: A — Approximately ₹22.76 lakh, identical to the real-cash-flow method.
Explanation. The nominal discount rate is 15.50%. Nominal inflows are ₹42 lakh, ₹55.125 lakh and ₹69.4575 lakh. Discounting these at 15.50% gives present values of approximately ₹36.3636 lakh, ₹41.3223 lakh and ₹45.0789 lakh. Total PV = ₹122.7648 lakh. Deducting ₹100 lakh gives NPV of ₹22.76 lakh. Consistent nominal and real approaches produce the same economic NPV.
Where it goes wrong. Assuming inflation increases NPV automatically even when both future cash flows and the discount rate are adjusted consistently.
Question 13 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project requires an initial investment of ₹1,50,00,000. The present value of all expected after-tax cash inflows, discounted at the required rate of return, is ₹1,65,00,000. Calculate the Benefit-Cost Ratio.
A project requires an initial investment of ₹1,50,00,000. The present value of all expected after-tax cash inflows, discounted at the required rate of return, is ₹1,65,00,000. Calculate the Benefit-Cost Ratio.
0.90 times
1.50 times
0.10 times
1.10 times (correct answer)
Answer: D — 1.10 times
Explanation. Benefit-Cost Ratio or Profitability Index = PV of cash inflows ÷ Initial cash outlay. Therefore, BCR = ₹1,65,00,000÷₹1,50,00,000 = 1.10 times. A value greater than 1 indicates that the present value of expected benefits exceeds the initial investment. Option c represents the excess of PV over investment as a proportion of investment, not the complete Benefit-Cost Ratio.
Where it goes wrong. Calculating only the surplus return ratio instead of the full present-value benefit-to-cost ratio.
Question 14 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A company evaluates a proposal requiring ₹80 lakh. The present value of its expected cash inflows is ₹76.80 lakh. What is the correct PI-based recommendation?
A company evaluates a proposal requiring ₹80 lakh. The present value of its expected cash inflows is ₹76.80 lakh. What is the correct PI-based recommendation?
PI is 0.96; reject the project. (correct answer)
PI is 1.04; accept the project.
PI is 0.04; reject the project.
PI is 1.96; accept the project.
Answer: A — PI is 0.96; reject the project.
Explanation. PI = PV of inflows ÷ Initial investment = ₹76.80 lakh÷₹80 lakh = 0.96. Since PI is below 1, the present value of inflows is lower than the initial investment, and the proposal should be rejected. The NPV is ₹76.80−₹80 = negative ₹3.20 lakh. Option c reports the relative shortfall rather than the PI itself.
Where it goes wrong. Mistaking the percentage shortfall for the PI or reversing the acceptability criterion.
Question 15 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company faces a capital budget of ₹100 lakh and has three indivisible independent projects:
| Project | Initial investment | PV of inflows | NPV |
|---|---:|---:|---:|
| A | ₹60 lakh | ₹80 lakh | ₹20 lakh |
| B | ₹50 lakh | ₹67 lakh | ₹17 lakh |
| C | ₹40 lakh | ₹53 lakh | ₹13 lakh |
Which feasible project combination maximises total NPV?
A company faces a capital budget of ₹100 lakh and has three indivisible independent projects:
| Project | Initial investment | PV of inflows | NPV |
|---|---:|---:|---:|
| A | ₹60 lakh | ₹80 lakh | ₹20 lakh |
| B | ₹50 lakh | ₹67 lakh | ₹17 lakh |
| C | ₹40 lakh | ₹53 lakh | ₹13 lakh |
Which feasible project combination maximises total NPV?
Projects B and C, total NPV ₹30 lakh.
Projects A and C, total NPV ₹33 lakh. (correct answer)
Projects A and B, total NPV ₹37 lakh.
Project A alone, total NPV ₹20 lakh.
Answer: B — Projects A and C, total NPV ₹33 lakh.
Explanation. A+C requires ₹60+₹40 = ₹100 lakh and produces total NPV of ₹20+₹13 = ₹33 lakh. B+C costs ₹90 lakh and gives NPV of ₹30 lakh. A+B costs ₹110 lakh, exceeding the budget. The individual alternatives generate NPVs below ₹33 lakh. Hence, A+C maximises total NPV among feasible combinations. Notice that B has a higher PI than A, yet the optimal portfolio is not selected by blindly ranking individual PIs.
Where it goes wrong. Assuming that selecting the highest individual PIs always produces the maximum total NPV when projects are indivisible.
Question 16 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project requires an initial outlay of ₹1,20,00,000 and generates after-tax cash inflows of ₹50,00,000, ₹60,00,000 and ₹70,00,000 at the end of Years 1, 2 and 3 respectively. The discount factors are 0.909, 0.826 and 0.751. Calculate the Profitability Index.
A project requires an initial outlay of ₹1,20,00,000 and generates after-tax cash inflows of ₹50,00,000, ₹60,00,000 and ₹70,00,000 at the end of Years 1, 2 and 3 respectively. The discount factors are 0.909, 0.826 and 0.751. Calculate the Profitability Index.
1.15 times
1.35 times
1.23 times (correct answer)
1.45 times
Answer: C — 1.23 times
Explanation. PV of Year 1 inflow = ₹50×0.909 = ₹45.45 lakh. Year 2 PV = ₹60×0.826 = ₹49.56 lakh. Year 3 PV = ₹70×0.751 = ₹52.57 lakh. Total PV = ₹147.58 lakh. PI = ₹147.58÷₹120 = 1.2298, approximately 1.23 times. The initial cash outlay is used as the denominator, not the total undiscounted cash inflows.
Where it goes wrong. Using undiscounted total inflows rather than their present value in the PI calculation.
Question 17 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. An investment of ₹100 lakh generates cash inflows of ₹40 lakh, ₹50 lakh and ₹60 lakh at the end of Years 1, 2 and 3 respectively. Using a reinvestment rate of 10%, calculate MIRR by the terminal-value method. Assume the initial investment is the only cash outflow.
An investment of ₹100 lakh generates cash inflows of ₹40 lakh, ₹50 lakh and ₹60 lakh at the end of Years 1, 2 and 3 respectively. Using a reinvestment rate of 10%, calculate MIRR by the terminal-value method. Assume the initial investment is the only cash outflow.
10.00%
15.00%
20.00%
17.78% (correct answer)
Answer: D — 17.78%
Explanation. Terminal value at Year 3 = ₹40×1.10² + ₹50×1.10 + ₹60 = ₹48.40+₹55+₹60 = ₹163.40 lakh. MIRR = (Terminal Value÷Initial Investment)^(1/3)−1. Therefore, MIRR = (163.40÷100)^(1/3)−1 = 17.78% approximately. The reinvestment periods are two years for Year 1 receipts and one year for Year 2 receipts.
Where it goes wrong. Compounding the Year 1 and Year 2 cash inflows for an incorrect number of periods or reporting the total terminal-value growth as annual MIRR.
Question 18 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project has the following cash-flow pattern:
| Year | Cash flow |
|---|---:|
| 0 | (₹100 lakh) |
| 1 | ₹50 lakh |
| 2 | (₹20 lakh) |
| 3 | ₹80 lakh |
The financing rate is 10% and the reinvestment rate is 12%. Calculate MIRR using the two-rate method. Use a two-year discount factor of 0.8264 at 10%.
A project has the following cash-flow pattern:
| Year | Cash flow |
|---|---:|
| 0 | (₹100 lakh) |
| 1 | ₹50 lakh |
| 2 | (₹20 lakh) |
| 3 | ₹80 lakh |
The financing rate is 10% and the reinvestment rate is 12%. Calculate MIRR using the two-rate method. Use a two-year discount factor of 0.8264 at 10%.
10.00%
12.00%
6.99% (correct answer)
15.00%
Answer: C — 6.99%
Explanation. PV of negative flows = ₹100 + ₹20×0.8264 = ₹116.528 lakh. Terminal value of positives at Year 3 = ₹50×1.12² + ₹80 = ₹62.72+₹80 = ₹142.72 lakh. MIRR = (₹142.72÷₹116.528)^(1/3)−1 = approximately 6.99%. The additional Year 2 outflow is discounted at the financing rate, while the Year 1 positive flow is compounded at the reinvestment rate.
Where it goes wrong. Using 12% for discounting the negative cash flow or 10% for reinvesting the positive cash flow.
Question 19 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project requires an initial outflow of ₹120 lakh and a further outflow of ₹30 lakh at the end of Year 2. Its positive cash flows are ₹40 lakh in Year 1, ₹50 lakh in Year 2 and ₹60 lakh in Year 3. The financing rate is 10%, the reinvestment rate is 12%, and the minimum acceptable return is 8%. Calculate MIRR and determine the investment decision.
A project requires an initial outflow of ₹120 lakh and a further outflow of ₹30 lakh at the end of Year 2. Its positive cash flows are ₹40 lakh in Year 1, ₹50 lakh in Year 2 and ₹60 lakh in Year 3. The financing rate is 10%, the reinvestment rate is 12%, and the minimum acceptable return is 8%. Calculate MIRR and determine the investment decision.
4.70%; reject (correct answer)
8.00%; accept
10.00%; accept
12.00%; accept
Answer: A — 4.70%; reject
Explanation. PV of outflows = ₹120 + ₹30÷1.10² = ₹120+₹24.7934 = ₹144.7934 lakh. Terminal value of positive inflows = ₹40×1.12² + ₹50×1.12 + ₹60 = ₹166.176 lakh. MIRR = (166.176÷144.7934)^(1/3)−1 = 4.70% approximately. Since 4.70% is below the required return of 8%, reject the project. The reinvestment rate is not the acceptance hurdle.
Where it goes wrong. Ignoring the Year 2 investment requirement or comparing MIRR against the reinvestment rate instead of the required minimum return.
Question 20 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. The nominal required rate of return is 16.60% and the expected annual inflation rate is 6%. Calculate the precise real required rate of return using the Fisher equation.
The nominal required rate of return is 16.60% and the expected annual inflation rate is 6%. Calculate the precise real required rate of return using the Fisher equation.
9.00%
10.00% (correct answer)
10.60%
11.00%
Answer: B — 10.00%
Explanation. Fisher equation: 1+Nominal rate = (1+Real rate)(1+Inflation). Therefore, 1+Real rate = 1.166÷1.06 = 1.10. Real rate = 1.10−1 = 10%. The precise real return is 10%. Subtracting inflation arithmetically from the nominal rate gives 10.60%, which is only an approximation and does not satisfy the precise Fisher relationship.
Where it goes wrong. Subtracting inflation from the nominal rate instead of rearranging and applying the precise Fisher equation.
Question 21 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company estimates that a project's Year 3 cash inflow will be ₹75 lakh in today's purchasing power. Annual inflation is expected to be 8%. Calculate the corresponding nominal Year 3 cash inflow.
A company estimates that a project's Year 3 cash inflow will be ₹75 lakh in today's purchasing power. Annual inflation is expected to be 8%. Calculate the corresponding nominal Year 3 cash inflow.
₹87.00 lakh
₹81.00 lakh
₹90.00 lakh
₹94.49 lakh (correct answer)
Answer: D — ₹94.49 lakh
Explanation. Nominal Year 3 cash flow = Real cash flow×(1+Inflation rate)³. Therefore, nominal value = ₹75×1.08³ = ₹75×1.259712 = ₹94.4784 lakh, approximately ₹94.49 lakh when expressed using the rounded annual factor or ₹94.48 lakh using full precision. The relevant option is the approximately ₹94.49 lakh nominal amount. Applying inflation for only two years would result in ₹87.48 lakh.
Where it goes wrong. Using the wrong number of inflation periods or rounding the compound inflation factor prematurely.
Question 22 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project requires an initial investment of ₹150 lakh and is expected to produce real after-tax cash inflows of ₹60 lakh annually for three years. The real required return is 8% and annual inflation is 4%. Calculate the NPV using the nominal cash flows and the corresponding nominal discount rate.
A project requires an initial investment of ₹150 lakh and is expected to produce real after-tax cash inflows of ₹60 lakh annually for three years. The real required return is 8% and annual inflation is 4%. Calculate the NPV using the nominal cash flows and the corresponding nominal discount rate.
₹4.63 lakh (correct answer)
₹10.00 lakh
(₹4.63 lakh)
₹154.63 lakh
Answer: A — ₹4.63 lakh
Explanation. Nominal rate = (1.08×1.04)−1 = 12.32%. Nominal cash flows are ₹62.40 lakh, ₹64.896 lakh and ₹67.49184 lakh. Discounting these at 12.32% produces the same PV as discounting ₹60 lakh annually at the real 8% rate. PV = 60/1.08 + 60/1.08² + 60/1.08³ = ₹154.6258 lakh. NPV = ₹154.6258−₹150 = ₹4.63 lakh.
Where it goes wrong. Using an inconsistent discount rate or treating total present value of inflows as NPV without deducting the initial outlay.
Question 23 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project generates a nominal cash inflow of ₹105 lakh at the end of Year 1. The inflation rate is 5%, and the real required return is 10%. An analyst incorrectly discounts this nominal cash flow using the real rate. By how much does this incorrect approach overstate the present value compared with the correct nominal-discounting method?
A project generates a nominal cash inflow of ₹105 lakh at the end of Year 1. The inflation rate is 5%, and the real required return is 10%. An analyst incorrectly discounts this nominal cash flow using the real rate. By how much does this incorrect approach overstate the present value compared with the correct nominal-discounting method?
₹2.50 lakh
₹5.00 lakh
₹4.55 lakh (correct answer)
₹10.00 lakh
Answer: C — ₹4.55 lakh
Explanation. Correct nominal required return = (1.10×1.05)−1 = 15.50%. Correct PV = ₹105÷1.155 = ₹90.9091 lakh. Incorrect PV using the real rate = ₹105÷1.10 = ₹95.4545 lakh. Overstatement = ₹95.4545−₹90.9091 = ₹4.5454 lakh, approximately ₹4.55 lakh. Nominal cash flows must be discounted using nominal rates to avoid overstating project value.
Where it goes wrong. Discounting inflation-adjusted nominal cash flows with a real discount rate, thereby overstating present value.
Question 24 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A project has a real required rate of return of 10% and a nominal required rate of return of 15.50%. Determine the annual inflation rate implied by the Fisher equation.
A project has a real required rate of return of 10% and a nominal required rate of return of 15.50%. Determine the annual inflation rate implied by the Fisher equation.
4%
5% (correct answer)
5.50%
6%
Answer: B — 5%
Explanation. Fisher relationship: (1+Nominal rate) = (1+Real rate)(1+Inflation rate). Therefore, 1+Inflation rate = 1.155÷1.10 = 1.05. Inflation rate = 1.05−1 = 5%. The precise inflation rate is therefore 5%. Option c results from subtracting the two rates directly, which ignores the interaction between the real return and inflation.
Where it goes wrong. Treating the difference between nominal and real rates as the precise inflation rate.
Question 25 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Two mutually exclusive investment proposals are being considered by a company:
| Particulars | Project X | Project Y |
|---|---:|---:|
| Initial cash outlay | ₹50 lakh | ₹100 lakh |
| PV of expected cash inflows | ₹70 lakh | ₹130 lakh |
| Project life | 4 years | 4 years |
Which conclusion correctly distinguishes the ranking under PI and NPV when the objective is maximisation of shareholders' wealth?
Two mutually exclusive investment proposals are being considered by a company:
| Particulars | Project X | Project Y |
|---|---:|---:|
| Initial cash outlay | ₹50 lakh | ₹100 lakh |
| PV of expected cash inflows | ₹70 lakh | ₹130 lakh |
| Project life | 4 years | 4 years |
Which conclusion correctly distinguishes the ranking under PI and NPV when the objective is maximisation of shareholders' wealth?
Both PI and NPV prefer Project X.
Both PI and NPV prefer Project Y.
PI prefers Project Y, whereas NPV prefers Project X.
PI prefers Project X with 1.40 times, whereas NPV prefers Project Y with ₹30 lakh. (correct answer)
Answer: D — PI prefers Project X with 1.40 times, whereas NPV prefers Project Y with ₹30 lakh.
Explanation. Project X PI = ₹70÷₹50 = 1.40; NPV = ₹70−₹50 = ₹20 lakh. Project Y PI = ₹130÷₹100 = 1.30; NPV = ₹130−₹100 = ₹30 lakh. PI ranks X higher because it generates more present value per rupee invested. NPV ranks Y higher because it creates a greater absolute addition to shareholders' wealth. For mutually exclusive projects, the wealth-maximising decision should follow the higher NPV.
Where it goes wrong. Confusing relative profitability measured by PI with absolute wealth creation measured by NPV.
What does this Investment Decisions (Capital Budgeting) - Test 4 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.
