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What is the importance of CA Final AFM Capital Budgeting in exams?
It helps students develop the ability to evaluate and compare projects, a skill tested in both theory and problem-solving questions.
How are NPV IRR questions different from simple payback method problems?
NPV and IRR consider the time value of money, while the simple payback method only focuses on the time taken to recover the investment.
Why is risk analysis included in capital budgeting sums?
Risk analysis helps assess how changes in factors like cost or discount rate affect project viability.
Can two projects with the same cost have different NPVs?
Yes, because the timing and amount of cash inflows can vary, affecting the total present value.
Which method is most reliable for project selection?
NPV is generally considered the most reliable, but using multiple methods together gives a better decision base.
Advanced Capital Budgeting Problems for CA Final AFM
Muskan Verma22 Aug, 2025
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CA Final AFM Capital Budgeting: Capital budgeting is an important concept for decision-making in financial management. For students preparing for the CA Final AFM Capital Budgeting, mastering problem-solving skills is important. Below, we’ve explained complex problems in simple terms, using examples similar to those in the exam. It also covers methods like NPV, IRR, and risk analysis that are common in NPV IRR questions, and capital budgeting sums.
Understanding CA Final AFM Capital Budgeting
In CA Final AFM Capital Budgeting, students learn how to decide whether a project is worth investing in. This is done by comparing the costs of the project with the expected benefits over time. The main tools used include Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index. These tools help in analysing whether a project will increase the company’s value. They also help in comparing multiple projects to choose the most profitable one.
Advanced Capital Budgeting Problems for CA Final AFM
Below, we’ve mentioned some CA Final AFM Capital Budgeting, including NPV IRR Questions, and Capital Budgeting Sums:
Problem Type 1
The cost of a project is ₹50,000, and it generates cash inflows of ₹20,000, ₹15,000, ₹25,000, and ₹10,000 over four years.
Required: Using the Present Value Index (PVI) method, appraise the profitability of the proposed investment, assuming a 10% rate of discount.
Solution: The first step is to calculate the present value and profitability index.
Year
Cash Inflows (₹)
Present Value Factor @10%
Present Value (₹)
1
20,000
0.909
18,180
2
15,000
0.826
12,390
3
25,000
0.751
18,775
4
10,000
0.683
6,830
Total PV
-
-
56,175
Total Present Value = ₹56,175
Less: Initial Outlay = ₹50,000
Net Present Value (NPV) = ₹6,175
Profitability Index (gross) = Present Value of Cash Inflows ÷ Initial Cash Outflow
= ₹56,175 ÷ ₹50,000 = 1.1235
Given that the Profitability Index (PI) is greater than 1.0, the proposal can be accepted.
Net Profitability Index (NPI) = NPV ÷ Initial Cash Outlay
= ₹6,175 ÷ ₹50,000 = 0.1235
Alternatively,
NPI = 1.1235 – 1 = 0.1235
Since the Net Profitability Index is positive, the project is considered profitable and can be accepted.
Problem Type 2
A company is considering whether to purchase a new machine. Machines A and B are available for ₹80,000 each. Earnings after taxation are as follows:
Year
Machine A (₹)
Machine B (₹)
1
24,000
8,000
2
32,000
24,000
3
40,000
32,000
4
24,000
48,000
5
16,000
32,000
Required: Evaluate the two alternatives using: (a) Payback Method (b) Rate of Return on Investment Method (c) Net Present Value Method (discount rate 10%)
(a) Payback Method
Machine A:
First 2 years = ₹24,000 + ₹32,000 = ₹56,000
Remaining to recover = ₹80,000 – ₹56,000 = ₹24,000
From Year 3 = ₹40,000 inflow → ₹24,000/₹40,000 = 3/5 year = 7.2 months
Payback Period = 2 years 7.2 months (≈ 2.6 years)
Machine B:
First 3 years = ₹8,000 + ₹24,000 + ₹32,000 = ₹64,000
Remaining to recover = ₹80,000 – ₹64,000 = ₹16,000
From Year 4 = ₹48,000 inflow → ₹16,000/₹48,000 = 1/3 year = 4 months
Payback Period = 3 years 4 months (≈ 3.33 years)
Result: Machine A is preferred (shorter payback).
(b) Rate of Return on Investment Method (ROI)
Particulars
Machine A
Machine B
Total Cash Flows
₹1,36,000
₹1,44,000
Average Annual Cash Flow
₹27,200
₹28,800
Annual Depreciation
₹16,000
₹16,000
Annual Net Savings
₹11,200
₹12,800
Average Investment
₹40,000
₹40,000
ROI (%)
28%
32%
Result: Machine B is preferred (higher ROI).
(c) Net Present Value Method (NPV)
Year
Discount Factor @10%
Machine A Cash Flow (₹)
Machine A PV (₹)
Machine B Cash Flow (₹)
Machine B PV (₹)
1
0.909
24,000
21,816
8,000
7,272
2
0.826
32,000
26,432
24,000
19,824
3
0.751
40,000
30,040
32,000
24,032
4
0.683
24,000
16,392
48,000
32,784
5
0.621
16,000
9,936
32,000
19,872
Total
-
₹1,36,000
₹1,04,616
₹1,44,000
₹1,03,784
Net Present Value:
Machine A = ₹1,04,616 – ₹80,000 = ₹24,616
Machine B = ₹1,03,784 – ₹80,000 = ₹23,784
Result: Machine A is preferred (higher NPV).
Final Conclusion:
Payback Method → Machine A
ROI Method → Machine B
NPV Method → Machine A
This shows that different evaluation methods can give different choices, which is an important point for CA Final AFM capital budgeting sums.
Problem Type 3
At the beginning of 2024, a business enterprise is trying to decide between two potential investments.
Required: Assuming a required rate of return of 10% p.a., evaluate the investment proposals under: (a) Return on Investment (b) Payback Period (c) Discounted Payback Period (d) Profitability Index
The forecast details are given below:
Particulars
Proposal A
Proposal B
Cost of Investment
₹20,000
₹28,000
Life
4 years
5 years
Scrap Value
Nil
Nil
Net Income (After Depreciation and Tax)
End of 2024
₹500
Nil
End of 2025
₹2,000
₹3,400
End of 2026
₹3,500
₹3,400
End of 2027
₹2,500
₹3,400
End of 2028
Nil
₹3,400
It is estimated that each of the alternative projects will require an additional working capital of ₹2,000, which will be recovered in full after the end of each project.
Depreciation is provided using the straight-line method.
Present value of ₹1 at 10% p.a.:
Year
1
2
3
4
5
PV
0.91
0.83
0.75
0.68
0.62
Solution
Step 1: Calculation of Cash Inflows
Year
Net Income (₹)
Depreciation (₹)
Cash Inflow (₹)
Net Income (₹)
Depreciation (₹)
Cash Inflow (₹)
Proposal A
Proposal B
2024
500
5,000
5,500
Nil
5,600
5,600
2025
2,000
5,000
7,000
3,400
5,600
9,000
2026
3,500
5,000
8,500
3,400
5,600
9,000
2027
2,500
5,000
7,500
3,400
5,600
9,000
2028
Nil
Nil
Nil
3,400
5,600
9,000
Total
8,500
20,000
28,500
13,600
28,000
41,600
(a) Return on Investment (ROI)
Particulars
Proposal A
Proposal B
Initial Investment + WC
₹20,000 + ₹2,000 = ₹22,000
₹28,000 + ₹2,000 = ₹30,000
Life (years)
4
5
Total Net Income
₹8,500
₹13,600
Average Annual Return
₹8,500 ÷ 4 = ₹2,125
₹13,600 ÷ 5 = ₹2,720
Average Investment
(₹22,000 + ₹2,000) ÷ 2 = ₹12,000
(₹30,000 + ₹2,000) ÷ 2 = ₹16,000
ROI (%)
(₹2,125 / ₹12,000) × 100 = 17.7%
(₹2,720 / ₹16,000) × 100 = 17%
Result: Proposal A gives a slightly higher ROI.
(b) Payback Period
Proposal A:
2024: ₹5,500 → Remaining ₹14,500
2025: ₹7,000 → Remaining ₹7,500
2026: ₹7,500 → Exactly recovers balance → 2.9 years
Proposal B:
2024: ₹5,600 → Remaining ₹22,400
2025: ₹9,000 → Remaining ₹13,400
2026: ₹9,000 → Remaining ₹4,400
2027: ₹4,400 / ₹9,000 = 0.5 year → Total 3.5 years
(c) Discounted Payback Period
Proposal A:
Year
Cash Inflow (₹)
PV Factor
PV (₹)
2024
5,500
0.91
5,005
2025
7,000
0.83
5,810
2026
8,500
0.75
6,375
2027
7,500
0.68
5,100
Recovery of ₹20,000 happens in 3.5 years.
Proposal B:
Year
Cash Inflow (₹)
PV Factor
PV (₹)
2024
5,600
0.91
5,096
2025
9,000
0.83
7,470
2026
9,000
0.75
6,750
2027
9,000
0.68
6,120
2028
9,000
0.62
5,580
Recovery of ₹28,000 happens in 4.4 years.
(d) Profitability Index Method
Particulars
Proposal A
Proposal B
PV of Inflows
₹22,290
₹31,016
Initial Outlay
₹20,000
₹28,000
Gross PI
(₹22,290 ÷ ₹20,000) × 100 = 111.45%
(₹31,016 ÷ ₹28,000) × 100 = 111.08%
Net PI
((₹22,290 – ₹20,000) ÷ ₹20,000) × 100 = 11.45%
((₹31,016 – ₹28,000) ÷ ₹28,000) × 100 = 10.8%
Final Conclusion:
ROI → Proposal A preferred
Payback → Proposal A preferred (faster recovery)
Discounted Payback → Proposal A preferred
Profitability Index → Proposal A preferred
Overall, Proposal A is financially more attractive.
How to Approach CA Final AFM Capital Budgeting Problems
Before solving, it is important to have a clear plan so that each step is accurate and efficient. Below, we’ve mentioned an approach for students on how they can solve CA Final AFM Capital Budgeting Problems
Read the question carefully: Students should check if cash flows are even or uneven, and note down all the given data, such as investment amount, discount rate, and scrap value.
Identify the method: Students should decide whether the problem requires NPV, IRR, Payback, PI, or Risk Analysis, and consider if more than one method is to be applied.
Apply the right formula: Write down the formula clearly before substituting values, and solve step-by-step to avoid mistakes, especially when discounting cash flows.
Interpret the result: Explain what the result means in the context of the project, and always state clearly whether it should be accepted, rejected, or compared with other options.
CA Final AFM Capital Budgeting is not just about formulas; it is about making logical investment decisions based on calculations. By practising NPV IRR questions and capital budgeting sums, students can strengthen their ability to analyse real-life investment scenarios. Adding risk analysis to the study plan will make preparation even stronger for the exam.
