Attempt CAIIB ABFM Case Study Practice Quiz & Download PDF

Q1. Vidarbha Infrastructure Ltd. has the following capital structure: • 10,000 equity shares of ₹100 each • 12% Debentures of ₹5,00,000 • Current EBIT = ₹1,80,000 • Tax rate = 30% Calculate the Degree of Financial Leverage (DFL) and interpret what it implies for shareholder risk.

DFL = 1.25; A 10% increase in EBIT will lead to a 12.5% increase in EPS.
DFL = 1.50; A 10% increase in EBIT will lead to a 15.0% increase in EPS.
DFL = 2.00; A 10% increase in EBIT will lead to a 20% increase in EPS.
DFL = 0.75; Financial leverage reduces the sensitivity of EPS to changes in EBIT.

Q2. A project manager at Global Exports Ltd. is evaluating a capital project. He presents the following two risk analysis approaches to the board: • Approach A: Changes one variable at a time (e.g., sales volume, price, cost) while keeping all others constant, to assess the impact on NPV. • Approach B: Simultaneously changes all key variables in the same direction (optimistic, base, or pessimistic scenario) to evaluate NPV under different states of the world. Identify the CORRECT names for Approach A and Approach B respectively, and explain the key difference.

Approach A = Simulation Analysis; Approach B = Decision Tree Analysis.
Approach A = Sensitivity Analysis; Approach B = Scenario Analysis.
Approach A = Scenario Analysis; Approach B = Sensitivity Analysis.
Approach A = Hillier Model; Approach B = Monte Carlo Simulation.

Q3. Pratham Pharmaceuticals Ltd. is evaluating Project Falcon with the following details: • Initial Investment: ₹50 lakhs • Annual Cash Inflows: ₹12 lakhs for 6 years • Discount Rate: 10% • PV Annuity Factor @ 10% for 6 years = 4.355 Calculate the NPV and determine whether the project should be accepted.

NPV = ₹2.26 lakhs (positive); Project should be ACCEPTED as it creates shareholder value.
NPV = -₹2.26 lakhs (negative); Project should be REJECTED as it destroys value.
NPV = ₹5.46 lakhs (positive); Project should be ACCEPTED.
NPV = -₹7.74 lakhs (negative); Project should be REJECTED.

Q4. Consider the following four capital budgeting techniques and their defining characteristics: 1. Payback Period (PBP) 2. Accounting Rate of Return (ARR) 3. Net Present Value (NPV) 4. Internal Rate of Return (IRR) Which of the following statements is CORRECT regarding their treatment of the time value of money (TVM)?

All four methods incorporate TVM by discounting future cash flows to present value.
Only PBP and ARR incorporate TVM; NPV and IRR do not.
Only NPV and IRR incorporate TVM through discounted cash flow analysis; PBP and ARR do not account for TVM.
ARR and NPV incorporate TVM; PBP and IRR do not.

Q5. The risk management team of Bharat Bank is evaluating an international loan portfolio. The portfolio includes loans to borrowers in countries with political instability, foreign currency restrictions, and sovereign default history. Which of the following BEST describes the types of risk the bank is specifically exposed to in this scenario?

Operational Risk and Liquidity Risk, arising from inadequate internal processes and inability to meet short-term obligations.
Country Risk and Exchange Rate Risk, arising from political/economic instability in the borrower’s country and adverse currency movements that affect repayment capacity.
Credit Risk alone, since all risks in international lending reduce to the probability of loan default.
Market Risk and Interest Rate Risk, arising from changes in benchmark rates that affect the bank’s borrowing costs.

Q6. The finance team of Mahesh Industries is evaluating Project Alpha with the following data: • Fixed Costs = ₹9,00,000 • Selling Price per unit = ₹150 • Variable Cost per unit = ₹90 Calculate the Break-Even Point (BEP) in units and in sales value, and identify the correct option.

BEP = 12,000 units; BEP (Sales) = ₹18,00,000
BEP = 15,000 units; BEP (Sales) = ₹22,50,000
BEP = 10,000 units; BEP (Sales) = ₹15,00,000
BEP = 18,000 units; BEP (Sales) = ₹27,00,000

Q7. A company has: • Sales = ₹80 lakh • Variable Cost = 60% of Sales • Fixed Cost = ₹12 lakh • EBIT = ? • Interest = ₹4 lakh Calculate: (i) Contribution, (ii) EBIT, (iii) Degree of Operating Leverage (DOL), and (iv) Degree of Financial Leverage (DFL).

Contribution = ₹32L, EBIT = ₹20L, DOL = 1.60, DFL = 1.25
Contribution = ₹32L, EBIT = ₹20L, DOL = 1.60, DFL = 1.60
Contribution = ₹32L, EBIT = ₹20L, DOL = 2.00, DFL = 1.60
Contribution = ₹28L, EBIT = ₹16L, DOL = 1.75, DFL = 1.33

Q8. According to the Capital Asset Pricing Model (CAPM), which of the following statements is/are CORRECT? Statement 1: The beta (β) of the market portfolio is always equal to 1. Statement 2: A security with β > 1 is more volatile than the market and commands a higher risk premium than the market portfolio. Statement 3: In CAPM, the total risk of a security is measured by beta, which includes both systematic and unsystematic risk.

Only Statements 1 and 2 are correct.
All three statements are correct.
Only Statement 3 is correct.
Only Statements 2 and 3 are correct.

Q9. Activity-Based Costing (ABC) was implemented at Precision Auto Parts Ltd. to improve cost accuracy. Before ABC, overhead was allocated based on direct labour hours. After ABC, the company found that Product A — a low-volume, complex part — was significantly UNDERCOSTED under the traditional system, while Product B — a high-volume, standard part — was OVERCOSTED. Which of the following BEST explains why this distortion occurred under the traditional costing system?

The traditional system correctly allocated costs; the distortion was caused by errors in the ABC system’s cost driver selection.
The traditional system used a single, volume-based allocation base (direct labour hours) that failed to capture the higher overhead consumption of low-volume complex products that consume more setups, inspections, and engineering support.
Product A was undercosted because it used fewer direct labour hours, and direct labour hours are the only accurate measure of overhead consumption.
ABC systems always overcost high-volume products and undercost low-volume products regardless of the nature of the overhead activities.

Q10. A financial analyst is evaluating an international capital budgeting project. The project generates cash flows in USD, but the parent company reports in INR. The analyst must decide whether to use foreign currency cash flows with a foreign currency discount rate, or convert cash flows to home currency. Which of the following approaches is theoretically CORRECT and why?

Always use home currency (INR) cash flows discounted at the home currency WACC, ignoring exchange rate forecasts entirely.
Both approaches (foreign currency discounted at foreign currency rate, OR home currency discounted at home currency rate) should yield the same NPV if interest rate parity holds and exchange rate forecasts are internally consistent.
Always use foreign currency cash flows with the risk-free rate of the foreign country as the discount rate.
The home currency approach always gives a higher NPV because Indian inflation rates are typically higher, increasing nominal rupee cash flows.

Q11. Consider the following statements about Relevant Costs in decision-making: Statement 1: Future incremental cash costs that differ between alternatives are relevant costs. Statement 2: Depreciation on an existing asset is always a relevant cost because it represents the annual cost of using the asset. Statement 3: Opportunity costs — the value of the next best alternative foregone — are relevant even though they are not recorded in accounting books. Which statement(s) is/are correct?

Only Statements 1 and 3 are correct.
All three statements are correct.
Only Statement 2 is correct.
Only Statements 2 and 3 are correct.

Q12. Assertion (A): The Modified Internal Rate of Return (MIRR) is considered a more reliable investment decision criterion than the traditional IRR method. Reason (R): MIRR corrects the reinvestment rate assumption of IRR by explicitly specifying a reinvestment rate (typically the cost of capital) for positive cash flows, avoiding the multiple IRR problem and providing a single, realistic return measure. Choose the correct answer:

Both A and R are true, and R is the correct explanation of A.
Both A and R are true, but R is NOT the correct explanation of A.
A is true, but R is false.
A is false, but R is true.

Q13. A decision tree is being used to evaluate a new product launch. The product development team identifies two decision nodes and three chance nodes. The expected monetary value (EMV) at a terminal node is ₹40 lakhs with probability 0.6 and ₹(-10) lakhs with probability 0.4. What is the EMV of this chance node, and what does a NEGATIVE EMV at a decision node imply?

EMV = ₹28 lakhs; a negative EMV means the path should be selected for its strategic value despite the financial loss.
EMV = ₹20 lakhs; a negative EMV at a decision node means the decision should be taken only if there are non-financial benefits.
EMV = ₹20 lakhs; a negative EMV at a decision node means that path should be pruned (rejected) since it does not maximise expected value.
EMV = ₹28 lakhs; negative EMV is always acceptable in public sector projects because social returns are more important.

Q14. Kaveri Textiles Ltd. is evaluating whether to replace an old machine with a new, more efficient one. The old machine was purchased 3 years ago for ₹20 lakhs and has a book value of ₹12 lakhs. Its current market value is ₹8 lakhs. The new machine costs ₹30 lakhs. For the purpose of capital budgeting, which of the following correctly identifies the RELEVANT costs/values in this replacement decision?

The ₹20 lakh original cost of the old machine is a relevant cost because it represents the total investment made.
The ₹12 lakh book value is a relevant cost because it appears on the balance sheet and affects depreciation calculations.
The ₹8 lakh current market (salvage) value of the old machine is relevant as it represents the opportunity cost of NOT selling it; and the ₹30 lakh cost of the new machine is the incremental investment.
Both the original cost and book value of the old machine are relevant because they affect the reported profit on disposal.

Q15. Sigma Corp has the following details for the current year: • Sales: ₹1,00,00,000 • Variable Costs: ₹65,00,000 • Fixed Costs: ₹20,00,000 • Interest on Debt: ₹3,00,000 • Number of Equity Shares: 1,00,000 • Tax Rate: 30% Calculate the Degree of Combined Leverage (DCL) and the % change in EPS if sales increase by 5%.

DCL = 2.50; EPS increases by 12.5%
DCL = 3.00; EPS increases by 15%
DCL = 2.33; EPS increases by 11.65%
DCL = 2.92; EPS increases by 14.58%

Q16. A project requires an initial investment of ₹60 lakhs. The project generates uncertain cash flows described as follows: • Best Case: ₹25 lakhs p.a. for 4 years (probability 30%) • Base Case: ₹18 lakhs p.a. for 4 years (probability 50%) • Worst Case: ₹10 lakhs p.a. for 4 years (probability 20%) • Discount Rate: 12%; PV factor annuity 4 years @12% = 3.037 Using Scenario Analysis, what is the expected NPV?

Expected NPV = ₹1.02 lakhs
Expected NPV = -₹5.46 lakhs
Expected NPV = ₹4.86 lakhs
Expected NPV = -₹3.44 lakhs

Q17. Which of the following best describes the DIFFERENCE between Transaction Exposure and Economic Exposure in foreign exchange risk management?

Transaction exposure is a long-term strategic risk; economic exposure is a short-term contractual risk affecting current cash flows.
Transaction exposure arises from existing contractual obligations in foreign currency (e.g., receivables, payables) whose value changes with exchange rate movements; Economic exposure is broader and captures the long-term impact of exchange rate changes on a firm’s competitive position and future cash flows.
Transaction exposure affects only importers; economic exposure affects only exporters in international trade.
Both exposures are identical in nature and the terms are used interchangeably in international financial management.

Q18. The following data is provided for Arjun Manufacturing Ltd.: • EBIT = ₹10,00,000 • Tax Rate = 40% • Depreciation = ₹1,50,000 • Capital Expenditure = ₹2,50,000 • Increase in Working Capital = ₹50,000 Calculate Free Cash Flow to Firm (FCFF).

FCFF = ₹5,50,000
FCFF = ₹6,00,000
FCFF = ₹4,50,000
FCFF = ₹7,00,000

Q19. Which of the following correctly explains the REINVESTMENT RATE ASSUMPTION inherent in the IRR method, and why it can be a limitation in capital budgeting?

IRR assumes that all intermediate cash flows are reinvested at the cost of capital (WACC), which is always realistic and never creates any bias.
IRR implicitly assumes that all intermediate cash flows are reinvested at the IRR itself. For high-IRR projects, this assumption can be unrealistically optimistic, overstating the project’s true attractiveness.
IRR assumes that intermediate cash flows are reinvested at the risk-free rate, making it overly conservative for high-return projects.
IRR makes no assumption about reinvestment, which is its main advantage over NPV and MIRR methods.

Q20. Consider the following comparative data for two mutually exclusive projects evaluated at a 12% discount rate: Project X: Initial Investment ₹40L, Annual Cash Flows ₹13L for 4 years; PV Annuity Factor @12%, 4 years = 3.037 Project Y: Initial Investment ₹60L, Annual Cash Flows ₹20L for 4 years; PV Annuity Factor @12%, 4 years = 3.037 Project X has a higher IRR (approximately 13.1%) while Project Y has a higher NPV. Which project should be selected to maximise shareholder value?

Project X, because a higher IRR always indicates a superior investment regardless of scale.
Project Y, because NPV measures the absolute increase in firm value and is the superior criterion for wealth maximisation.
Neither project, since both have positive NPV and the firm should wait for better options.
Project X, since smaller initial investment reduces financial risk even if NPV is lower.