CA Final Advanced Financial Management Notes by PW for January 2027 Exam

A capital budgeting decision requires you to assess a project's financial viability while accounting for possible changes in its assumptions. A variation in sales price, unit cost, sales volume or project duration can change the expected NPV. Similarly, selecting a replacement machine involves comparing costs over different periods rather than looking at the purchase price alone. Knowing how to evaluate these factors is essential for solving practical AFM questions.

PW’s AFM – Super 30 notes help you work through Advanced Capital Budgeting Decisions, focusing on sensitivity analysis and replacement decisions. Understand how the forward and reverse approaches measure the effect of changing project variables, practise project lifetime sensitivity calculations and learn to compare replacement options using effective annual cost (EAC). The past-year question analysis further helps you identify recurring examination areas and direct your revision towards important concepts.

CA Final Advanced Financial Management Questions

1. XYZ Ltd. is considering a project for which the following estimates are available:
   Initial cost of the project Rs.10,00,000
   Sales price per unit Rs.60
   Cost per unit Rs.40
   Sales volumes: Year 1 20,000 units, Year 2 30,000 units, Year 3 30,000 units
   Discount rate is 10% p.a.
   You are required to measure the sensitivity of the project in relation to each of the following parameters: (a) sales price per unit, (b) unit cost, (c) sales volume, (d) initial outlay and (e) project lifetime. Taxation may be ignored.

Solution:
Contribution per unit = Rs.60 − Rs.40 = Rs.20
NPV = PV of cash flows − Initial investment
= (20,000 × 20)/1.1 + (30,000 × 20)/1.21 + (30,000 × 20)/1.331 − Rs.10,00,000
= Rs.3,63,636 + Rs.4,95,868 + Rs.4,50,789 − Rs.10,00,000
= Rs.13,10,293 − Rs.10,00,000
= Rs.3,10,293

(a) Sales price:
Let the sales price at which NPV is zero be S.
0 = 20,000(S − 40)/1.1 + 30,000(S − 40)/1.21 + 30,000(S − 40)/1.331 − Rs.10,00,000
(S − 40) × Rs.65,514 = Rs.10,00,000
S − 40 = Rs.15.26
S = Rs.55.26
Fall in sales price = (60 − 55.26)/60 = 7.9%
Alternative method (adverse change of 10%, new price Rs.54, contribution Rs.14):
NPV = −Rs.10,00,000 + Rs.2,54,545 + Rs.3,47,107 + Rs.3,15,552 = −Rs.82,796
Change in NPV = (3,10,293 − (−82,796))/3,10,293 × 100 = 126.7%

(b) Unit cost:
At sales price Rs.60, the unit cost that gives a margin of Rs.15.26 = Rs.60 − Rs.15.26 = Rs.44.74
Rise in unit cost = (44.74 − 40)/40 × 100 = 11.85%
Alternative method (adverse change of 10%, new cost Rs.44, contribution Rs.16):
NPV = −Rs.10,00,000 + Rs.2,90,909 + Rs.3,96,694 + Rs.3,60,631 = Rs.48,234
Change in NPV = (3,10,293 − 48,234)/3,10,293 × 100 = 84.46%

(c) Sales volume:
Fall in sales volume = 3,10,293/13,10,293 × 100 = 23.7%
Alternative method (adverse change of 10%):
NPV = −Rs.10,00,000 + (18,000 × 20)/1.1 + (27,000 × 20)/1.21 + (27,000 × 20)/1.331
= −Rs.10,00,000 + Rs.3,27,272 + Rs.4,46,281 + Rs.4,05,710
= Rs.1,79,263
Change in NPV = (3,10,293 − 1,79,263)/3,10,293 × 100 = 42.22%

(d) Initial outlay:
PV of inflows remains Rs.13,10,293, so the initial outlay can rise to the same amount.
Rise in initial outlay = 3,10,293/10,00,000 × 100 = 31.03%
Alternative method (adverse change of 10%, outlay Rs.11,00,000):
NPV = −Rs.11,00,000 + Rs.3,63,636 + Rs.4,95,868 + Rs.4,50,789 = Rs.2,10,293
Change in NPV = (3,10,293 − 2,10,293)/3,10,293 × 100 = 32.22%

(e) Project lifetime:
PV of first two years = Rs.4,00,000 × 0.909 + Rs.6,00,000 × 0.826
= Rs.3,63,600 + Rs.4,95,600
= Rs.8,59,200
NPV after two years = −Rs.10,00,000 + Rs.8,59,200 = −Rs.1,40,800
PV of third-year cash flow = 30,000 × Rs.20 × 0.751 = Rs.4,50,600
Per day PV (360 days) = Rs.4,50,600/360 = Rs.1,252
Days needed to recover Rs.1,40,800 = Rs.1,40,800/Rs.1,252 = 112 days
Revised project life = 2 years + 112/360 = 2.311 years
Fall in project life = (3 − 2.311)/3 × 100 = 22.97%
Answer: Break-even sales price is Rs.55.26 (fall of 7.9%). Unit cost can rise by 11.85%. Sales volume can fall by 23.7%. Initial outlay can rise by 31.03%. Project life can fall by 22.97%. Project life is the most sensitive parameter, as it needs the lowest change to make NPV zero.

2. The Easygoing Company Limited is considering a new project with an initial investment for a product “Survival”. The IRR of the project is estimated at 16% with an estimated life of 5 years.
   The Financial Manager has studied the project with sensitivity analysis and informed that annual fixed cost sensitivity is 7.8416%, whereas cost of capital (discount rate) sensitivity is 60%.
   Other information: Profit Volume ratio (P/V) is 70%, variable cost is Rs.60 per unit and annual cash flow is Rs.57,500.
   Ignore depreciation on initial investment and the impact of taxation.
   Cumulative discounting factor for 5 years: 8% 3.993, 9% 3.890, 10% 3.791, 11% 3.696, 12% 3.605, 13% 3.517, 14% 3.433, 15% 3.352, 16% 3.274, 17% 3.199, 18% 3.127.
   Calculate: (i) initial investment of the project, (ii) net present value of the project, (iii) annual fixed cost, (iv) estimated annual unit sales and (v) break-even units.

Solution:
(i) Initial investment:
At IRR, NPV is zero.
Initial investment = Annual cash flow × AF (16%, 5)
= Rs.57,500 × 3.274
= Rs.1,88,255

(ii) Net present value:
Let the cost of capital be X.
(16 − X)/X = 60%
X = 10%
NPV = Rs.57,500 × AF (10%, 5) − Rs.1,88,255
= Rs.57,500 × 3.791 − Rs.1,88,255
= Rs.2,17,982.50 − Rs.1,88,255
= Rs.29,727.50

(iii) Annual fixed cost:
Let the change in fixed cost that makes NPV zero be X.
Rs.29,727.50 − 3.791X = 0
X = Rs.7,841.60
Let the original fixed cost be Y.
Y × 7.8416% = Rs.7,841.60
Y = Rs.1,00,000

(iv) Estimated annual unit sales:
Selling price per unit = Rs.60/(100% − 70%) = Rs.200
Annual sales value = (Annual cash flow + Fixed cost)/P/V ratio
= (Rs.57,500 + Rs.1,00,000)/0.70
= Rs.2,25,000
Annual unit sales = Rs.2,25,000/Rs.200 = 1,125 units

(v) Break-even units:
Contribution per unit = Rs.200 − Rs.60 = Rs.140
Break-even units = Fixed cost/Contribution per unit
= Rs.1,00,000/Rs.140
= 714.29 units
Answer: (i) Initial investment Rs.1,88,255 (ii) NPV Rs.29,727.50 (iii) Annual fixed cost Rs.1,00,000 (iv) Annual unit sales 1,125 units (v) Break-even units 714.29

3. A company has an old machine having book value zero. The company is thinking of choosing one of the following two alternatives:
   (i) Spend Rs.10,00,000 to upgrade the old existing machine.
   (ii) Purchase a new machine for Rs.20,00,000, with installation cost of Rs.50,000. The old machine will be sold for Rs.50,000.
   Both proposals envisage a useful life of five years with nil salvage value.
   The expected after-tax profits for the three alternatives are as under:
   Year 1: Old machine Rs.5,00,000, upgraded machine Rs.5,50,000, new machine Rs.6,00,000
   Year 2: Old machine Rs.5,40,000, upgraded machine Rs.5,90,000, new machine Rs.6,40,000
   Year 3: Old machine Rs.5,80,000, upgraded machine Rs.6,10,000, new machine Rs.6,90,000
   Year 4: Old machine Rs.6,20,000, upgraded machine Rs.6,50,000, new machine Rs.7,40,000
   Year 5: Old machine Rs.6,60,000, upgraded machine Rs.7,00,000, new machine Rs.8,00,000
   The tax rate is 40%. The company follows the straight line method of depreciation. Assume the cost of capital to be 15%.
   You are required to advise the company as to which alternative is to be adopted.

Solution:
(A) Cash outflow:
If the machine is upgraded: upgradation cost = Rs.10,00,000
If a new machine is installed:
Cost = Rs.20,00,000
Add: Installation cost = Rs.50,000
Total cost = Rs.20,50,000
Less: Disposal of old machine, Rs.50,000 − 40% tax = Rs.30,000
Total cash outflow = Rs.20,20,000

Working notes:
Depreciation if the machine is upgraded = Rs.10,00,000/5 = Rs.2,00,000
Depreciation if a new machine is installed = Rs.20,50,000/5 = Rs.4,10,000
The old machine has a book value of zero, so there is no depreciation on it.

(B) Cash inflow after tax (CFAT) = EAT + Depreciation
Incremental CFAT is the CFAT of the alternative less the CFAT of the old machine.
Upgraded machine:
Year 1: 5,50,000 + 2,00,000 = 7,50,000. Incremental = 7,50,000 − 5,00,000 = Rs.2,50,000
Year 2: 5,90,000 + 2,00,000 = 7,90,000. Incremental = 7,90,000 − 5,40,000 = Rs.2,50,000
Year 3: 6,10,000 + 2,00,000 = 8,10,000. Incremental = 8,10,000 − 5,80,000 = Rs.2,30,000
Year 4: 6,50,000 + 2,00,000 = 8,50,000. Incremental = 8,50,000 − 6,20,000 = Rs.2,30,000
Year 5: 7,00,000 + 2,00,000 = 9,00,000. Incremental = 9,00,000 − 6,60,000 = Rs.2,40,000
New machine:
Year 1: 6,00,000 + 4,10,000 = 10,10,000. Incremental = 10,10,000 − 5,00,000 = Rs.5,10,000
Year 2: 6,40,000 + 4,10,000 = 10,50,000. Incremental = 10,50,000 − 5,40,000 = Rs.5,10,000
Year 3: 6,90,000 + 4,10,000 = 11,00,000. Incremental = 11,00,000 − 5,80,000 = Rs.5,20,000
Year 4: 7,40,000 + 4,10,000 = 11,50,000. Incremental = 11,50,000 − 6,20,000 = Rs.5,30,000
Year 5: 8,00,000 + 4,10,000 = 12,10,000. Incremental = 12,10,000 − 6,60,000 = Rs.5,50,000

(C) Present value at 15%:
Upgraded machine:
Year 1: 2,50,000 × 0.870 = Rs.2,17,500
Year 2: 2,50,000 × 0.756 = Rs.1,89,000
Year 3: 2,30,000 × 0.658 = Rs.1,51,340
Year 4: 2,30,000 × 0.572 = Rs.1,31,560
Year 5: 2,40,000 × 0.497 = Rs.1,19,280
Total PV of CFAT = Rs.8,08,680
NPV = Rs.8,08,680 − Rs.10,00,000 = −Rs.1,91,320
New machine:
Year 1: 5,10,000 × 0.870 = Rs.4,43,700
Year 2: 5,10,000 × 0.756 = Rs.3,85,560
Year 3: 5,20,000 × 0.658 = Rs.3,42,160
Year 4: 5,30,000 × 0.572 = Rs.3,03,160
Year 5: 5,50,000 × 0.497 = Rs.2,73,350
Total PV of CFAT = Rs.17,47,930
NPV = Rs.17,47,930 − Rs.20,20,000 = −Rs.2,72,070
Answer: The NPV is negative for both proposals (−Rs.1,91,320 for upgrading and −Rs.2,72,070 for the new machine), so the company should continue with the existing old machine.

4. A & Co. is contemplating whether to replace an existing machine or to spend money on overhauling it. The replacement machine costs Rs.90,000 now and requires maintenance of Rs.10,000 at the end of every year for eight years. At the end of eight years, it would have a salvage value of Rs.20,000 and would be sold.
   The existing machine requires increasing amounts of maintenance each year, and its salvage value falls each year as follows:
   Present: Maintenance Rs.0, salvage Rs.40,000
   Year 1: Maintenance Rs.10,000, salvage Rs.25,000
   Year 2: Maintenance Rs.20,000, salvage Rs.15,000
   Year 3: Maintenance Rs.30,000, salvage Rs.10,000
   Year 4: Maintenance Rs.40,000, salvage Rs.0
   The opportunity cost of capital for A & Co. is 15%.
   Required: When should the company replace the machine?

Solution:
Equivalent annual cost (EAC) of the new machine:
Cost of new machine now = Rs.90,000
Add: PV of annual maintenance (Rs.10,000 × 4.4873) = Rs.44,873
= Rs.1,34,873
Less: PV of salvage value at the end of 8 years (Rs.20,000 × 0.3269) = Rs.6,538
PV of cash outflow = Rs.1,28,335
EAC = Rs.1,28,335/4.4873 = Rs.28,600

Optimal replacement period (PV of outflows at 15%):
Replace immediately:
Year 0: Sale of old machine = Rs.(40,000)
Years 1 to 4: EAC Rs.28,600 × 2.855 = Rs.81,652
Total = Rs.41,652
Replace after 1 year:
Year 1: Maintenance Rs.10,000 × 0.870 = Rs.8,696
Year 1: Salvage Rs.(25,000) × 0.870 = Rs.(21,739)
Years 2 to 4: EAC Rs.28,600 × 1.985 = Rs.56,783
Total = Rs.43,739
Replace after 2 years:
Year 1: Maintenance Rs.10,000 × 0.870 = Rs.8,696
Year 2: Maintenance Rs.20,000 × 0.756 = Rs.15,123
Year 2: Salvage Rs.(15,000) × 0.756 = Rs.(11,342)
Years 3 and 4: EAC Rs.28,600 × 1.229 = Rs.35,157
Total = Rs.47,633
Replace after 3 years:
Year 1: Rs.8,696
Year 2: Rs.15,123
Year 3: Maintenance Rs.30,000 × 0.658 = Rs.19,725
Year 3: Salvage Rs.(10,000) × 0.658 = Rs.(6,575)
Year 4: EAC Rs.28,600 × 0.572 = Rs.16,352
Total = Rs.53,321
Replace after 4 years:
Year 1: Rs.8,696
Year 2: Rs.15,123
Year 3: Rs.19,725
Year 4: Maintenance Rs.40,000 × 0.572 = Rs.22,870
Total = Rs.66,414
The lowest present value of outflow is Rs.41,652, when the machine is replaced immediately.
Answer: The company should replace the machine immediately.

CA Final Advanced Financial Management Notes PDF 

Download the CA Final Advanced Financial Management Notes PDF and keep your AFM revision material handy. Use it to revisit key calculations, check your understanding of capital budgeting concepts and practise applying them to examination-style problems.

Why Use CA Final Advanced Financial Management Notes by PW?

Use the notes to strengthen your understanding of the calculations involved in capital budgeting and practise applying them to different decision-making scenarios. You can use them to:

• Understand Sensitivity Analysis: Learn how changes in important project variables, such as selling price, annual cash flow and initial investment, affect the Net Present Value (NPV) of a project.

• Compare Forward and Reverse Approaches: Revise the two methods of sensitivity analysis, including how to calculate changes in NPV after an adverse change and how to determine the change in a variable required to bring NPV to zero.

• Calculate Sensitivity for Different Project Variables: Practise assessing the impact of changes in sales price, unit cost, sales volume, initial investment, fixed costs, annual running costs and annual cash flows.

• Solve Project Lifetime Sensitivity Problems: Understand how to calculate the revised project period using annual present values, daily cash flows and the time required to reach the break-even NPV.

• Apply Sensitivity Analysis to Exam Questions: Work through practical problems involving NPV, break-even values and sensitivity calculations, including questions based on past examination and test-your-knowledge.

• Understand Replacement Decisions: Learn how to evaluate machinery replacement using Effective Annual Cost (EAC) and compare the present value of cash outflows over different useful lives.

• Determine the Optimal Replacement Cycle: Revise how to compare different replacement scenarios by calculating maintenance and repair costs, present values and effective annual costs to identify the option with the lowest annual cost.

• Review Past-Year Exam Trends: Use the chapter-wise analysis to identify frequently tested concepts and understand the marks and question patterns associated with sensitivity analysis and replacement decisions.

Turn your capital budgeting revision into active practice with PW’s AFM – Super 30 notes. Test yourself on sensitivity analysis, work through NPV calculations and compare machine replacement options using EAC. As you solve each question, focus on the logic behind the calculations so you can tackle similar problems more confidently in the CA Final examination. 

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