Test 5: Investment Decisions (Capital Budgeting): answer key
This chapter-wise practice test covers Investment Decisions (Capital Budgeting) - Test 5 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 planning a major expansion of its solar-module manufacturing capacity. The investment committee has identified four independent production projects. All proposals have positive NPVs at the company's approved discount rate, but the annual capital expenditure budget is restricted. The management wants to compare two situations: one in which the projects can be undertaken partially and another in which each project must be undertaken in its entirety.
The company has an existing capital structure comprising 60% equity and 40% long-term debt carrying an annual coupon rate of 9%. Its current EBIT is ₹240 lakh, applicable corporate tax rate is 25%, and estimated equity beta is 1.15. The approved post-tax WACC for the proposals is 12%. The company's average working-capital operating cycle is 50 days. The NPVs supplied below are already calculated at the approved WACC and reflect all relevant post-tax project cash flows.
**Capital investment proposals (₹ lakh)**
| Project | Initial Investment | NPV |
|---|---:|---:|
| A | 40 | 20 |
| B | 30 | 12 |
| C | 50 | 17.50 |
| D | 20 | 6 |
**Available capital budget: ₹100 lakh.**
The proposals are technically independent and do not depend on the acceptance of any other project. If projects are divisible, management may invest in a fraction of a proposal and receive the corresponding proportional share of its NPV. If projects are indivisible, however, each selected proposal requires its entire initial investment. The investment committee wants to maximise the aggregate NPV without exceeding the available budget. It has specifically instructed the finance team not to assume that the individual project ranking automatically determines the optimal combination under indivisible capital rationing. All investment amounts occur at the beginning of the period, and the stated NPVs are measured at the same valuation date.
Calculate the NPV per rupee of capital invested for Project B, which is used for ranking divisible independent projects under capital rationing.
₹0.30 per rupee
₹0.50 per rupee
₹0.40 per rupee (correct answer)
₹0.60 per rupee
Answer: C — ₹0.40 per rupee
Explanation. Under divisible capital rationing, projects are ranked by NPV per rupee of capital invested. For Project B, NPV = ₹12 lakh and investment = ₹30 lakh. Therefore, NPV per rupee = 12÷30 = ₹0.40. This means every rupee invested generates ₹0.40 of NPV. Option a results from using the wrong investment amount, while option b corresponds to Project A's ratio rather than Project B's.
Where it goes wrong. Dividing investment by NPV instead of NPV by investment, or confusing NPV per rupee with total project NPV.
Question 2 · 2 marks · Investment Decisions (Capital Budgeting) · hard
When all four projects are divisible, determine the project allocation that maximises aggregate NPV without exceeding the ₹100 lakh capital budget.
A fully, B fully and 60% of C; aggregate NPV ₹42.50 lakh. (correct answer)
A fully, B fully and D fully; aggregate NPV ₹38 lakh.
B fully, C fully and 50% of D; aggregate NPV ₹42.50 lakh.
A fully, C fully and 50% of B; aggregate NPV ₹43 lakh.
Answer: A — A fully, B fully and 60% of C; aggregate NPV ₹42.50 lakh.
Explanation. NPV per rupee invested is A = 20/40 = 0.50; B = 12/30 = 0.40; C = 17.50/50 = 0.35; and D = 6/20 = 0.30. Select A and B first, requiring ₹70 lakh and generating ₹32 lakh NPV. The remaining ₹30 lakh funds 60% of C, generating ₹17.50×60% = ₹10.50 lakh. Total NPV = ₹42.50 lakh with exactly ₹100 lakh invested.
Where it goes wrong. Ranking projects by absolute NPV instead of NPV per rupee invested, or failing to allocate the remaining budget fractionally.
Question 3 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Assuming that the projects are indivisible, determine the feasible combination that produces the maximum aggregate NPV within the ₹100 lakh capital budget.
A and C; investment ₹90 lakh; NPV ₹37.50 lakh.
B, C and D; investment ₹100 lakh; NPV ₹35.50 lakh.
A and C and D; investment ₹110 lakh; NPV ₹43.50 lakh.
A, B and D; investment ₹90 lakh; NPV ₹38 lakh. (correct answer)
Answer: D — A, B and D; investment ₹90 lakh; NPV ₹38 lakh.
Explanation. Under indivisible capital rationing, every selected proposal must be undertaken in full. A+B+D requires ₹40+₹30+₹20 = ₹90 lakh and generates NPV of ₹20+₹12+₹6 = ₹38 lakh. A+C generates ₹37.50 lakh, while B+C+D generates ₹35.50 lakh. A+C+D exceeds the ₹100 lakh ceiling. Therefore, A+B+D is the optimal feasible combination.
Where it goes wrong. Selecting projects solely in PI ranking order without checking complete feasible combinations or exceeding the capital ceiling.
Question 4 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Calculate the combined Profitability Index of the indivisible portfolio selected in Question 3.
1.30 times
1.42 times (correct answer)
1.50 times
1.22 times
Answer: B — 1.42 times
Explanation. The selected portfolio consists of Projects A, B and D. Aggregate initial investment = ₹40+₹30+₹20 = ₹90 lakh. PV of total inflows equals investment plus NPV for each project: A = ₹60 lakh, B = ₹42 lakh and D = ₹26 lakh. Aggregate PV of inflows = ₹128 lakh. Portfolio PI = ₹128÷₹90 = 1.4222, approximately 1.42 times. It is calculated from aggregate values, not an average of individual PIs.
Where it goes wrong. Calculating the portfolio PI using the average of individual project indices instead of aggregate present values.
Question 5 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. Zenith Power Systems Ltd. is evaluating two mutually exclusive production technologies for its industrial electrical equipment division. The alternatives have unequal useful lives. Technology Alpha is expected to remain operational for two years, whereas Technology Beta has an expected life of three years. The company can replace either technology when its useful life expires and expects identical replacement opportunities to remain available at the same investment cost and operating cash-flow pattern.
The company's capital structure consists of 65% equity and 35% long-term debt carrying a coupon rate of 9.25%. Its current EBIT is ₹310 lakh, estimated equity beta is 1.30 and corporate tax rate is 25%. The approved post-tax WACC is 10%. The manufacturing division operates with an average working-capital cycle of 60 days. Project cash flows below are incremental and already include all applicable operating expenses, taxes and working-capital movements.
**Investment information (₹ lakh)**
| Particulars | Alpha | Beta |
|---|---:|---:|
| Initial investment | 60 | 80 |
| Useful life | 2 years | 3 years |
| Annual cash inflow | 40 | 40 |
**Discounting information at 10%**
| Period | PV factor |
|---|---:|
| Year 1 | 0.909 |
| Year 2 | 0.826 |
| Year 3 | 0.751 |
| PVAF for 2 years | 1.736 |
| PVAF for 3 years | 2.487 |
For the Replacement Chain Method, both projects are assumed to be repeatable under unchanged economic conditions over a common six-year period. For the Equivalent Annualized Criterion, divide the NPV of each project by its corresponding PVAF at the approved WACC. The investment committee wants to assess both methods because a direct comparison of NPVs calculated over unequal lives may produce an inappropriate ranking. No additional terminal receipts or replacement costs other than the stated repeat investments arise.
Calculate the NPV of Technology Beta at the approved WACC of 10%.
₹19.44 lakh (correct answer)
₹9.44 lakh
₹39.44 lakh
₹80.00 lakh
Answer: A — ₹19.44 lakh
Explanation. Technology Beta requires ₹80 lakh initially and produces ₹40 lakh annually for three years. PV of inflows = ₹40×0.909 + ₹40×0.826 + ₹40×0.751 = ₹36.36+₹33.04+₹30.04 = ₹99.44 lakh. NPV = ₹99.44−₹80 = ₹19.44 lakh. Option b incorrectly deducts the initial investment a second time or omits part of the discounted inflows.
Where it goes wrong. Subtracting the initial investment incorrectly or omitting one year's discounted cash inflow.
Question 6 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the Equivalent Annualized Criterion of Technology Alpha using its NPV and the supplied two-year PVAF.
₹7.82 lakh
₹9.40 lakh
₹5.41 lakh (correct answer)
₹10.60 lakh
Answer: C — ₹5.41 lakh
Explanation. Technology Alpha has an initial investment of ₹60 lakh and annual cash inflows of ₹40 lakh for two years. Its NPV at 10% is ₹40×0.909 + ₹40×0.826 − ₹60 = ₹69.40−₹60 = ₹9.40 lakh. Equivalent Annualized Criterion = NPV÷PVAF = ₹9.40÷1.736 = ₹5.4147 lakh, approximately ₹5.41 lakh per annum. The annualized value is not the same as its total NPV.
Where it goes wrong. Dividing NPV by project life rather than the present-value annuity factor applicable to the project's life.
Question 7 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Using the Equivalent Annualized Criterion, determine which technology should be selected between Alpha and Beta.
Alpha, because its initial investment is lower.
Beta, because its equivalent annualized value is approximately ₹7.82 lakh compared with Alpha's ₹5.41 lakh. (correct answer)
Alpha, because its NPV is ₹9.40 lakh.
Beta, because its total NPV is ₹19.44 lakh without any adjustment for unequal lives.
Answer: B — Beta, because its equivalent annualized value is approximately ₹7.82 lakh compared with Alpha's ₹5.41 lakh.
Explanation. Alpha's EAA = ₹9.40÷1.736 = ₹5.41 lakh. Beta's NPV is ₹19.44 lakh and its three-year PVAF is 2.487. Therefore, Beta's EAA = ₹19.44÷2.487 = ₹7.82 lakh. Beta provides the higher equivalent annualized value. The direct comparison of ₹9.40 lakh and ₹19.44 lakh NPVs would not properly adjust for their unequal useful lives.
Where it goes wrong. Comparing total NPVs directly when project lives differ instead of comparing their equivalent annualized values.
Question 8 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Apply the Replacement Chain Method over a common six-year period and calculate the combined six-year NPV of Technology Beta, assuming an identical replacement opportunity after Year 3.
₹19.44 lakh
₹29.44 lakh
₹23.58 lakh
₹34.04 lakh (correct answer)
Answer: D — ₹34.04 lakh
Explanation. Beta's first three-year project NPV is ₹19.44 lakh at Year 0. An identical replacement starts at the end of Year 3 and contributes another NPV of ₹19.44 lakh at that date. Discounting the second NPV to Year 0 gives ₹19.44×0.751 = ₹14.5994 lakh. Combined six-year NPV = ₹19.44+₹14.5994 = ₹34.0394 lakh, approximately ₹34.04 lakh.
Where it goes wrong. Adding the second project's NPV without discounting it from its replacement date to the common valuation date.
Question 9 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. Aditya Automotive Ltd. manufactures transmission systems and precision automotive components. Its production department has recommended replacing an ageing machine with a modern automated machine. The proposed replacement is expected to reduce annual manufacturing expenses, improve production efficiency and increase reliability. The finance department must prepare an incremental cash-flow analysis rather than evaluating the new machine's accounting profit in isolation.
The company has a capital structure of 60% equity and 40% long-term debt carrying a coupon rate of 9.50%. Its existing EBIT is ₹200 lakh, estimated equity beta is 1.10 and the corporate tax rate is 25%. The approved post-tax project discount rate is 10%. The manufacturing facility operates with an average working-capital cycle of 45 days.
**Replacement information (₹ lakh)**
| Particulars | Existing Machine | New Machine |
|---|---:|---:|
| Historical purchase cost | 60 | 95 |
| Installation cost | Already installed | 5 |
| Annual depreciation | 6 | 20 |
| Annual cash operating expenses | 85 | 60 |
| Tax WDV at replacement date | 30 | Not applicable |
| Useful life | Existing asset available for replacement | 4 years |
Additional information:
- Net sale proceeds of the old machine are ₹24 lakh.
- The old machine is the only asset in its tax block, and the block ceases to exist upon disposal.
- The tax saving arising from the disposal loss is immediately available.
- Additional working capital of ₹4 lakh is required at commencement and is fully released at the end of Year 4.
- The new machine has a residual value of ₹20 lakh at the end of Year 4, equal to its tax WDV at that date.
- The incremental operating cash savings remain constant throughout the four-year period.
- The new asset is depreciated on a straight-line basis as specified above.
All project operating cash flows are incremental and post-tax. The company must exclude historical costs of the existing machine and must consider the tax consequences of its disposal. The investment committee requires the replacement decision to be based on incremental NPV rather than gross operating savings alone. Use the supplied discount factors and assume all annual operating cash flows and terminal receipts occur at year-end.
Calculate the initial net cash outflow for replacing the existing machine, considering installation, additional working capital, sale proceeds and the tax benefit on disposal.
₹80.00 lakh
₹102.50 lakh
₹78.50 lakh (correct answer)
₹85.00 lakh
Answer: C — ₹78.50 lakh
Explanation. New machine cost including installation = ₹95+₹5 = ₹100 lakh. Add additional working capital of ₹4 lakh, making ₹104 lakh. The old machine is sold for ₹24 lakh and its WDV is ₹30 lakh, creating a disposal loss of ₹6 lakh. Tax saving = ₹6×25% = ₹1.50 lakh. Net initial outflow = ₹104−₹24−₹1.50 = ₹78.50 lakh. Historical purchase cost of the old machine is irrelevant.
Where it goes wrong. Omitting the tax saving on disposal loss or using the historical purchase cost of the old machine.
Question 10 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Determine the immediate tax effect arising from the disposal of the old machine, given that its tax WDV is ₹30 lakh and its net sale proceeds are ₹24 lakh.
Tax saving of ₹1.50 lakh (correct answer)
Tax outflow of ₹1.50 lakh
Tax saving of ₹6 lakh
Tax outflow of ₹6 lakh
Answer: A — Tax saving of ₹1.50 lakh
Explanation. WDV of the old machine is ₹30 lakh, whereas net sale proceeds are ₹24 lakh. As the old machine is the only asset in its block and the block ceases, the difference of ₹6 lakh constitutes a disposal loss under the stated treatment. Tax saving = ₹6 lakh×25% = ₹1.50 lakh. The disposal loss itself is ₹6 lakh, but the resulting tax benefit is only ₹1.50 lakh.
Where it goes wrong. Confusing the disposal loss with its tax saving or reversing the direction of the tax effect.
Question 12 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Calculate the incremental NPV of replacing the existing machine using a 10% discount rate. Use a four-year PVAF of 3.170 and a Year 4 discount factor of 0.683.
₹16.39 lakh
₹8.50 lakh
(₹8.42 lakh)
₹8.42 lakh (correct answer)
Answer: D — ₹8.42 lakh
Explanation. Initial net outflow is ₹78.50 lakh. PV of annual incremental CFAT = ₹22.25×3.170 = ₹70.5325 lakh. Terminal receipts comprise sale proceeds of ₹20 lakh and working-capital release of ₹4 lakh, totalling ₹24 lakh. PV of terminal receipts = ₹24×0.683 = ₹16.392 lakh. Total PV of benefits = ₹86.9245 lakh. Incremental NPV = ₹86.9245−₹78.50 = ₹8.4245 lakh, approximately ₹8.42 lakh. Replacement is financially justified.
Where it goes wrong. Ignoring the terminal working-capital release or deducting disposal tax again even though sale proceeds equal the new asset's terminal tax WDV.
Question 13 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A company has an investment budget of ₹100 lakh and three independent divisible projects:
| Project | Investment | NPV |
|---|---:|---:|
| P | ₹40 lakh | ₹18 lakh |
| Q | ₹50 lakh | ₹20 lakh |
| R | ₹30 lakh | ₹9 lakh |
What is the maximum aggregate NPV achievable when partial investment in a project is permitted?
A company has an investment budget of ₹100 lakh and three independent divisible projects:
| Project | Investment | NPV |
|---|---:|---:|
| P | ₹40 lakh | ₹18 lakh |
| Q | ₹50 lakh | ₹20 lakh |
| R | ₹30 lakh | ₹9 lakh |
What is the maximum aggregate NPV achievable when partial investment in a project is permitted?
₹38 lakh
₹40 lakh
₹41 lakh (correct answer)
₹43 lakh
Answer: C — ₹41 lakh
Explanation. NPV per rupee: P = 18/40 = 0.45; Q = 20/50 = 0.40; R = 9/30 = 0.30. Select P and Q first, investing ₹40+₹50 = ₹90 lakh and earning ₹38 lakh NPV. The remaining ₹10 lakh funds one-third of R, generating ₹9×1/3 = ₹3 lakh NPV. Total investment = ₹100 lakh and total NPV = ₹38+₹3 = ₹41 lakh.
Where it goes wrong. Ignoring partial project acceptance or ranking the divisible projects by absolute NPV rather than NPV per rupee invested.
Question 14 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company has a capital budget of ₹100 lakh and the following indivisible projects:
| Project | Investment | NPV |
|---|---:|---:|
| A | ₹60 lakh | ₹26 lakh |
| B | ₹50 lakh | ₹23 lakh |
| C | ₹40 lakh | ₹19 lakh |
| D | ₹30 lakh | ₹14 lakh |
Which combination maximises total NPV without breaching the capital budget?
A company has a capital budget of ₹100 lakh and the following indivisible projects:
| Project | Investment | NPV |
|---|---:|---:|
| A | ₹60 lakh | ₹26 lakh |
| B | ₹50 lakh | ₹23 lakh |
| C | ₹40 lakh | ₹19 lakh |
| D | ₹30 lakh | ₹14 lakh |
Which combination maximises total NPV without breaching the capital budget?
A and C; total investment ₹100 lakh and NPV ₹45 lakh. (correct answer)
B and C; total investment ₹90 lakh and NPV ₹42 lakh.
A and D; total investment ₹90 lakh and NPV ₹40 lakh.
B and D; total investment ₹80 lakh and NPV ₹37 lakh.
Answer: A — A and C; total investment ₹100 lakh and NPV ₹45 lakh.
Explanation. Because projects are indivisible, complete combinations must be examined. A+C costs ₹60+₹40 = ₹100 lakh and produces NPV of ₹26+₹19 = ₹45 lakh. B+C gives ₹42 lakh, A+D gives ₹40 lakh, and B+D gives ₹37 lakh. A+B exceeds the capital budget. Therefore, A+C produces the highest aggregate NPV among feasible combinations.
Where it goes wrong. Using a simple PI ranking instead of examining feasible complete project combinations under indivisible capital rationing.
Question 15 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Two mutually exclusive technologies have unequal lives. At a discount rate of 10%, their NPVs and corresponding annuity factors are:
| Particulars | Technology M | Technology N |
|---|---:|---:|
| NPV | ₹18.40 lakh | ₹29.50 lakh |
| Useful life | 2 years | 4 years |
| PVAF | 1.736 | 3.170 |
Calculate their equivalent annualized values and identify the better alternative.
Two mutually exclusive technologies have unequal lives. At a discount rate of 10%, their NPVs and corresponding annuity factors are:
| Particulars | Technology M | Technology N |
|---|---:|---:|
| NPV | ₹18.40 lakh | ₹29.50 lakh |
| Useful life | 2 years | 4 years |
| PVAF | 1.736 | 3.170 |
Calculate their equivalent annualized values and identify the better alternative.
M ₹9.40 lakh; N ₹9.31 lakh; select M.
M ₹10.60 lakh; N ₹10.00 lakh; select N.
M ₹9.31 lakh; N ₹10.60 lakh; select M.
M ₹10.60 lakh; N ₹9.31 lakh; select M. (correct answer)
Answer: D — M ₹10.60 lakh; N ₹9.31 lakh; select M.
Explanation. Equivalent annual value = NPV÷PVAF. For M, EAA = ₹18.40÷1.736 = ₹10.599 lakh, approximately ₹10.60 lakh. For N, EAA = ₹29.50÷3.170 = ₹9.306 lakh, approximately ₹9.31 lakh. Technology M provides the higher equivalent annualized value and should be selected, assuming repeatable investment opportunities and comparable operating conditions.
Where it goes wrong. Choosing Technology N solely because its total NPV is higher without adjusting for the difference in project lives.
Question 16 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Project X has a useful life of two years and an NPV of ₹12 lakh. Project Y has a useful life of four years and an NPV of ₹20 lakh. Both are mutually exclusive and repeatable under identical conditions. The discount rate is 10%, and the Year 2 discount factor is 0.826. Calculate the four-year replacement-chain NPV of Project X and identify the preferable alternative.
Project X has a useful life of two years and an NPV of ₹12 lakh. Project Y has a useful life of four years and an NPV of ₹20 lakh. Both are mutually exclusive and repeatable under identical conditions. The discount rate is 10%, and the Year 2 discount factor is 0.826. Calculate the four-year replacement-chain NPV of Project X and identify the preferable alternative.
₹12.00 lakh; select Project Y.
₹21.91 lakh; select Project X. (correct answer)
₹24.00 lakh; select Project X.
₹20.00 lakh; select Project Y.
Answer: B — ₹21.91 lakh; select Project X.
Explanation. Project X is undertaken at Year 0 and repeated at the end of Year 2. First-cycle NPV = ₹12 lakh. The replacement project's NPV at Year 2 is also ₹12 lakh; its present value is ₹12×0.826 = ₹9.912 lakh. Total four-year replacement-chain NPV = ₹12+₹9.912 = ₹21.912 lakh, approximately ₹21.91 lakh. Project Y has a four-year NPV of ₹20 lakh, so X is preferable under the common-life comparison.
Where it goes wrong. Adding replacement-cycle NPVs without discounting the later replacement cycle to the initial valuation date.
Question 17 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company proposes replacing an old machine. The new machine costs ₹75 lakh and installation costs ₹4 lakh. Additional working capital of ₹2 lakh is required. The old machine can be sold for ₹18 lakh, while its tax WDV is ₹22 lakh. The old machine is the only asset in its block and the tax rate is 30%. Calculate the initial net cash outflow.
A company proposes replacing an old machine. The new machine costs ₹75 lakh and installation costs ₹4 lakh. Additional working capital of ₹2 lakh is required. The old machine can be sold for ₹18 lakh, while its tax WDV is ₹22 lakh. The old machine is the only asset in its block and the tax rate is 30%. Calculate the initial net cash outflow.
₹63.00 lakh
₹81.00 lakh
₹61.80 lakh (correct answer)
₹62.40 lakh
Answer: C — ₹61.80 lakh
Explanation. New machine and installation cost = ₹75+₹4 = ₹79 lakh. Add working capital of ₹2 lakh, giving ₹81 lakh. Disposal proceeds are ₹18 lakh against WDV of ₹22 lakh, producing a loss of ₹4 lakh. Tax saving = ₹4×30% = ₹1.20 lakh. Initial net outflow = ₹81−₹18−₹1.20 = ₹61.80 lakh. The historical cost of the old machine is irrelevant to the current replacement decision.
Where it goes wrong. Treating the disposal loss as a tax expense instead of a tax saving, or omitting the additional working-capital requirement.
Question 18 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company replaces an old machine with a new machine. Annual cash operating expenses under the old and new machines are ₹80 lakh and ₹62 lakh respectively. Annual depreciation is ₹7 lakh on the old machine and ₹16 lakh on the new machine. Assuming a tax rate of 30%, calculate the annual incremental CFAT arising from the replacement.
A company replaces an old machine with a new machine. Annual cash operating expenses under the old and new machines are ₹80 lakh and ₹62 lakh respectively. Annual depreciation is ₹7 lakh on the old machine and ₹16 lakh on the new machine. Assuming a tax rate of 30%, calculate the annual incremental CFAT arising from the replacement.
₹15.30 lakh (correct answer)
₹18.00 lakh
₹12.60 lakh
₹20.10 lakh
Answer: A — ₹15.30 lakh
Explanation. Annual cash operating savings = ₹80−₹62 = ₹18 lakh. Incremental depreciation = ₹16−₹7 = ₹9 lakh. Incremental EBIT = ₹18−₹9 = ₹9 lakh. Tax at 30% = ₹2.70 lakh, so incremental PAT = ₹6.30 lakh. Add back the differential depreciation of ₹9 lakh. Incremental CFAT = ₹6.30+₹9 = ₹15.30 lakh. Both new and old depreciation must be considered.
Where it goes wrong. Adding back the new machine's entire depreciation instead of only the incremental depreciation over the old machine.
Question 19 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company is considering a replacement with the following information:
- New machine cost: ₹80 lakh.
- Installation cost: ₹5 lakh.
- Increase in working capital: ₹3 lakh.
- Net sale proceeds of old machine: ₹25 lakh.
- Tax WDV of old machine: ₹30 lakh.
- The old machine is the only asset in its block, which ceases upon sale.
- Tax rate: 25%.
- Annual operating cash savings: ₹22 lakh.
- Annual depreciation on new and old machines: ₹18 lakh and ₹8 lakh respectively.
- Useful life of new machine: 4 years.
- Year 4 sale value of new machine: ₹8 lakh, equal to its tax WDV.
- Full additional working capital is released at the end of Year 4.
At a 10% discount rate, use a four-year PVAF of 3.170 and a Year 4 PV factor of 0.683. Calculate the incremental NPV.
A company is considering a replacement with the following information:
- New machine cost: ₹80 lakh.
- Installation cost: ₹5 lakh.
- Increase in working capital: ₹3 lakh.
- Net sale proceeds of old machine: ₹25 lakh.
- Tax WDV of old machine: ₹30 lakh.
- The old machine is the only asset in its block, which ceases upon sale.
- Tax rate: 25%.
- Annual operating cash savings: ₹22 lakh.
- Annual depreciation on new and old machines: ₹18 lakh and ₹8 lakh respectively.
- Useful life of new machine: 4 years.
- Year 4 sale value of new machine: ₹8 lakh, equal to its tax WDV.
- Full additional working capital is released at the end of Year 4.
At a 10% discount rate, use a four-year PVAF of 3.170 and a Year 4 PV factor of 0.683. Calculate the incremental NPV.
Question 20 · 2 marks · Investment Decisions (Capital Budgeting) · medium
Scenario. A project has a useful life of five years and an NPV of ₹36.05 lakh at the applicable discount rate. The five-year present-value annuity factor is 3.605. Calculate the equivalent annualized value of the project.
A project has a useful life of five years and an NPV of ₹36.05 lakh at the applicable discount rate. The five-year present-value annuity factor is 3.605. Calculate the equivalent annualized value of the project.
₹12.00 lakh
₹10.00 lakh (correct answer)
₹7.21 lakh
₹18.03 lakh
Answer: B — ₹10.00 lakh
Explanation. The Equivalent Annualized Criterion is calculated by dividing the project's NPV by the present-value annuity factor applicable to its useful life. EAA = ₹36.05 lakh÷3.605 = ₹10.00 lakh per annum. This expresses the project's total NPV as an equivalent annual value and is useful when comparing mutually exclusive projects with unequal lives. Option c divides by five instead of using the annuity factor.
Where it goes wrong. Dividing NPV by the number of project years rather than by the corresponding PVAF.
Question 21 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company has a capital expenditure budget of ₹120 lakh. Four independent divisible projects are available:
| Project | Initial investment | NPV |
|---|---:|---:|
| A | ₹60 lakh | ₹30 lakh |
| B | ₹40 lakh | ₹18 lakh |
| C | ₹50 lakh | ₹20 lakh |
| D | ₹30 lakh | ₹6 lakh |
Determine the optimal allocation and maximum aggregate NPV.
A company has a capital expenditure budget of ₹120 lakh. Four independent divisible projects are available:
| Project | Initial investment | NPV |
|---|---:|---:|
| A | ₹60 lakh | ₹30 lakh |
| B | ₹40 lakh | ₹18 lakh |
| C | ₹50 lakh | ₹20 lakh |
| D | ₹30 lakh | ₹6 lakh |
Determine the optimal allocation and maximum aggregate NPV.
A and C fully; NPV ₹50 lakh.
B and C fully; NPV ₹38 lakh.
A and B fully and 40% of C; NPV ₹56 lakh. (correct answer)
A and D fully and 60% of B; NPV ₹40.80 lakh.
Answer: C — A and B fully and 40% of C; NPV ₹56 lakh.
Explanation. NPV per rupee invested: A = 30/60 = 0.50; B = 18/40 = 0.45; C = 20/50 = 0.40; D = 6/30 = 0.20. Allocate ₹60 lakh to A and ₹40 lakh to B. This uses ₹100 lakh and generates NPV of ₹48 lakh. The remaining ₹20 lakh funds 40% of C, generating ₹8 lakh NPV. Total investment = ₹120 lakh and aggregate NPV = ₹56 lakh.
Where it goes wrong. Allocating the capital budget using total NPV rankings or overlooking the possibility of partial investment in the final project.
Question 22 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company is considering replacing an existing machine. The proposed new machine costs ₹80 lakh and installation costs ₹5 lakh. Additional working capital of ₹3 lakh is required. The existing machine can be sold for ₹28 lakh, while its tax WDV is ₹20 lakh. The old machine is the only asset in its block and the block ceases upon disposal. The tax rate is 30%. Calculate the initial net cash outflow after disposal tax effects.
A company is considering replacing an existing machine. The proposed new machine costs ₹80 lakh and installation costs ₹5 lakh. Additional working capital of ₹3 lakh is required. The existing machine can be sold for ₹28 lakh, while its tax WDV is ₹20 lakh. The old machine is the only asset in its block and the block ceases upon disposal. The tax rate is 30%. Calculate the initial net cash outflow after disposal tax effects.
₹62.40 lakh (correct answer)
₹57.60 lakh
₹88.00 lakh
₹60.00 lakh
Answer: A — ₹62.40 lakh
Explanation. New machine and installation cost = ₹80+₹5 = ₹85 lakh. Add additional working capital of ₹3 lakh, giving ₹88 lakh. Sale proceeds of ₹28 lakh exceed tax WDV of ₹20 lakh by ₹8 lakh, creating a taxable gain. Tax outflow = ₹8×30% = ₹2.40 lakh. Initial net cash outflow = ₹88−₹28+₹2.40 = ₹62.40 lakh. Disposal tax is an additional outflow, not a tax saving.
Where it goes wrong. Treating a sale proceeds amount above WDV as a disposal loss and deducting a tax saving instead of adding tax payable.
Question 23 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A replacement proposal generates annual cash operating savings of ₹30 lakh. Annual depreciation is ₹18 lakh on the new machine and ₹6 lakh on the existing machine. If the applicable tax rate is 25%, calculate the incremental annual CFAT.
A replacement proposal generates annual cash operating savings of ₹30 lakh. Annual depreciation is ₹18 lakh on the new machine and ₹6 lakh on the existing machine. If the applicable tax rate is 25%, calculate the incremental annual CFAT.
₹22.50 lakh
₹18.00 lakh
₹30.00 lakh
₹25.50 lakh (correct answer)
Answer: D — ₹25.50 lakh
Explanation. Incremental depreciation = ₹18−₹6 = ₹12 lakh. Incremental EBIT = Operating savings ₹30−₹12 = ₹18 lakh. Tax = ₹18×25% = ₹4.50 lakh. Incremental PAT = ₹13.50 lakh. Add back the differential depreciation of ₹12 lakh. Therefore, incremental CFAT = ₹13.50+₹12 = ₹25.50 lakh. The tax shield on additional depreciation is reflected through the lower tax payment.
Where it goes wrong. Applying tax directly to gross operating savings or adding back the entire new depreciation without adjusting for old depreciation.
Question 24 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. Two mutually exclusive machines have unequal useful lives. The NPV of Machine A is ₹18 lakh over two years, while the NPV of Machine B is ₹26 lakh over three years. At the applicable discount rate, the two-year and three-year PVAFs are 1.736 and 2.487 respectively. Calculate their equivalent annualized values and identify the superior alternative.
Two mutually exclusive machines have unequal useful lives. The NPV of Machine A is ₹18 lakh over two years, while the NPV of Machine B is ₹26 lakh over three years. At the applicable discount rate, the two-year and three-year PVAFs are 1.736 and 2.487 respectively. Calculate their equivalent annualized values and identify the superior alternative.
A: ₹10.45 lakh; B: ₹10.37 lakh; select A.
A: ₹10.37 lakh; B: ₹10.45 lakh; select B. (correct answer)
A: ₹9.00 lakh; B: ₹8.67 lakh; select A.
A: ₹18 lakh; B: ₹26 lakh; select B.
Answer: B — A: ₹10.37 lakh; B: ₹10.45 lakh; select B.
Explanation. Machine A's EAA = ₹18÷1.736 = ₹10.3687 lakh, approximately ₹10.37 lakh. Machine B's EAA = ₹26÷2.487 = ₹10.4544 lakh, approximately ₹10.45 lakh. Machine B provides the higher annualized value and is preferred under the Equivalent Annualized Criterion. Although A has a shorter life and a slightly different annualized result, the comparison must be based on NPV divided by the appropriate PVAF for each useful life.
Where it goes wrong. Comparing the total NPVs directly or dividing each NPV by the wrong project's annuity factor.
Question 25 · 2 marks · Investment Decisions (Capital Budgeting) · hard
Scenario. A company has a capital budget of ₹150 lakh and four independent indivisible projects:
| Project | Investment | NPV |
|---|---:|---:|
| A | ₹90 lakh | ₹42 lakh |
| B | ₹80 lakh | ₹39 lakh |
| C | ₹70 lakh | ₹35 lakh |
| D | ₹60 lakh | ₹31 lakh |
Which combination maximises total NPV without exceeding the available capital budget?
A company has a capital budget of ₹150 lakh and four independent indivisible projects:
| Project | Investment | NPV |
|---|---:|---:|
| A | ₹90 lakh | ₹42 lakh |
| B | ₹80 lakh | ₹39 lakh |
| C | ₹70 lakh | ₹35 lakh |
| D | ₹60 lakh | ₹31 lakh |
Which combination maximises total NPV without exceeding the available capital budget?
A and D; total investment ₹150 lakh; NPV ₹73 lakh.
C and D; total investment ₹130 lakh; NPV ₹66 lakh.
B and C; total investment ₹150 lakh; NPV ₹74 lakh. (correct answer)
B and D; total investment ₹140 lakh; NPV ₹70 lakh.
Answer: C — B and C; total investment ₹150 lakh; NPV ₹74 lakh.
Explanation. Evaluate the feasible combinations. A+D costs ₹150 lakh and generates ₹73 lakh NPV. B+C costs ₹80+₹70 = ₹150 lakh and generates ₹39+₹35 = ₹74 lakh. C+D generates ₹66 lakh, while B+D generates ₹70 lakh. A+B and A+C exceed the budget. Therefore, B+C maximises aggregate NPV at ₹74 lakh. Individual project ranking cannot replace the trial-combination method when projects are indivisible.
Where it goes wrong. Selecting projects only according to their individual NPV-per-rupee ranking instead of comparing all feasible indivisible combinations.
What does this Investment Decisions (Capital Budgeting) - Test 5 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.
