Question Tag: Islamic Finance

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  • 20 Marks

FM – Nov 2018 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for machine acquisition using present value and compare traditional financing with Islamic finance.

Tamilore Limited (TL) is an agro-based firm, specializing in yam and rice production in Benue State of Nigeria. One of the harvesters is due to be replaced on November 30, 2018, the last day of TL’s current financial year. An investment appraisal exercise has recently been completed which confirmed that it is financially beneficial to replace the machine at this point. TL is now considering how best to finance the acquisition of the harvester to be replaced. TL is already highly geared.

A government development agency has offered the following two alternative methods of financing the machine:

Alternative 1
A loan of N49,200,000 at 6% interest rate to buy the machine on November 30, 2018. If this option is selected, the machine will be depreciated on a straight-line basis over its estimated useful life of 5 years.

Alternative 2
Enter into a finance lease. This will involve payment of annual rental of N12 million with the first payment due on November 30, 2019. The lease payments will be for the entire estimated useful life of the machine, which is 5 years, after which ownership will pass to TL without further payment.

Other information

(i) Whether leased or purchased outright, maintenance would remain the responsibility of TL and would be N450,000 payable annually in advance.
(ii) TL is liable to tax at a rate of 25%, payable annually at the end of the year in which the tax charge or tax saving arises.
(iii) TL is able to claim capital allowances on the full capital cost of the machine in equal installments over the first four years of the machine.
(iv) Assume that TL has sufficient taxable profits to benefit from any savings arising therefrom.
(v) All workings in N’000.

Required:

a. Show that the implied interest rate in the lease agreement is 7%. (3 Marks)

b. Advise, using present value method, whether Tamilore Limited should borrow to buy the machine or lease it. (12 Marks)

c. Instead of lease financing, one director has suggested an equivalent Islamic finance.

i. Explain briefly the principles of Islamic finance. (2 Marks)

ii. Explain three main advantages of Islamic finance. (3 Marks)

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  • 25 Marks

FM – NOV 2018 – L2 – Q2 – Islamic Finance | Sources of finance: equity

Covers Islamic finance focusing on Riba, rights issue calculations and determining the cost of capital for projects.

a) Islamic financing is an emerging model of financing in the global financial markets.

Required:

i) Explain the term Riba in Islamic Finance.
(2 marks)

ii) Explain the THREE (3) perspectives from which Riba can be viewed as forbidden or unacceptable in Islamic Finance.
(3 marks)

b) The Board of Directors of Continental Bank Ghana Ltd (CBGL) decided through a Board resolution to raise additional capital through rights issue to meet the new capital requirement by Bank of Ghana. CBGL plans to issue 1 new share for every 3 shares held by existing shareholders at 10% discount to its existing market price. CBGL currently has 6 million shares in issue at a book value of 2 cedis per share. CBGL maintains a dividend payout ratio of 50% and earnings per share currently is 1.6 cedis. Dividend growth is 5% per annum and this is expected into the foreseeable future. CBGL’s cost of equity is 15%. The issue cost is 600,000 cedis.

Required:

i) Calculate the market price per share.
(2 marks)

ii) Calculate the capitalization of CBGL.
(2 marks)

iii) Calculate the rights issue price.
(2 marks)

iv) Calculate the theoretical ex-right price.
(2 marks)

v) Calculate the market capitalization after the rights issue.
(2 marks)

c) KAF is a manufacturer of consumer electronics based in Accra, Ghana. KAF finances its investments with a combination of equity and debt. Its equity capital comprises 10 million shares which are currently trading on the stock exchange at GH¢2.55 per share. Its equity beta is 2.1 currently. The return on the risk-free security is 12.5% while the equity risk premium is 10%.

Included in KAF’s debt stock are irredeemable bonds that have a total face value of GH¢10 million while their total market value is GH¢12 million. The annual coupon of the irredeemable bonds is 18% but is paid semiannually.

The directors of the company are considering two new investment opportunities, which are described below:

  • Project 1: This is an expansion project in the consumer electronics manufacturing industry. It involves the setting up of a new factory in the northern part of Ghana. KAF would finance it with existing capital.
  • Project 2: This involves the installation of a new factory to manufacture furniture for export to foreign markets. Although this investment is a completely new line of business, KAF plans to finance it with existing capital. The average equity beta for the furniture manufacturing industry is 1.52 and the average industry capital structure is 60% equity and 40% debt.

It is expected that KAF’s tax rate will remain at 22%.

Required:

i) Compute the cost of capital that should be used as a discount rate for appraising Project 1.
(5 marks)

ii) Compute the cost of capital that should be used as a discount rate for appraising Project 2.
(5 marks)

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  • 6 Marks

FM – NOV 2015 – L2 – Q3c – Islamic Finance

Explain the terms Mudaraba, Musharaka, and Murabaha contracts in Islamic finance.

Explain the following types of contracts:
i. Mudaraba contract (2 marks)
ii. Musharaka contract (2 marks)
iii. Murabaha contract (2 marks)

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  • 20 Marks

FM – Nov 2018 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for machine acquisition using present value and compare traditional financing with Islamic finance.

Tamilore Limited (TL) is an agro-based firm, specializing in yam and rice production in Benue State of Nigeria. One of the harvesters is due to be replaced on November 30, 2018, the last day of TL’s current financial year. An investment appraisal exercise has recently been completed which confirmed that it is financially beneficial to replace the machine at this point. TL is now considering how best to finance the acquisition of the harvester to be replaced. TL is already highly geared.

A government development agency has offered the following two alternative methods of financing the machine:

Alternative 1
A loan of N49,200,000 at 6% interest rate to buy the machine on November 30, 2018. If this option is selected, the machine will be depreciated on a straight-line basis over its estimated useful life of 5 years.

Alternative 2
Enter into a finance lease. This will involve payment of annual rental of N12 million with the first payment due on November 30, 2019. The lease payments will be for the entire estimated useful life of the machine, which is 5 years, after which ownership will pass to TL without further payment.

Other information

(i) Whether leased or purchased outright, maintenance would remain the responsibility of TL and would be N450,000 payable annually in advance.
(ii) TL is liable to tax at a rate of 25%, payable annually at the end of the year in which the tax charge or tax saving arises.
(iii) TL is able to claim capital allowances on the full capital cost of the machine in equal installments over the first four years of the machine.
(iv) Assume that TL has sufficient taxable profits to benefit from any savings arising therefrom.
(v) All workings in N’000.

Required:

a. Show that the implied interest rate in the lease agreement is 7%. (3 Marks)

b. Advise, using present value method, whether Tamilore Limited should borrow to buy the machine or lease it. (12 Marks)

c. Instead of lease financing, one director has suggested an equivalent Islamic finance.

i. Explain briefly the principles of Islamic finance. (2 Marks)

ii. Explain three main advantages of Islamic finance. (3 Marks)

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  • 25 Marks

FM – NOV 2018 – L2 – Q2 – Islamic Finance | Sources of finance: equity

Covers Islamic finance focusing on Riba, rights issue calculations and determining the cost of capital for projects.

a) Islamic financing is an emerging model of financing in the global financial markets.

Required:

i) Explain the term Riba in Islamic Finance.
(2 marks)

ii) Explain the THREE (3) perspectives from which Riba can be viewed as forbidden or unacceptable in Islamic Finance.
(3 marks)

b) The Board of Directors of Continental Bank Ghana Ltd (CBGL) decided through a Board resolution to raise additional capital through rights issue to meet the new capital requirement by Bank of Ghana. CBGL plans to issue 1 new share for every 3 shares held by existing shareholders at 10% discount to its existing market price. CBGL currently has 6 million shares in issue at a book value of 2 cedis per share. CBGL maintains a dividend payout ratio of 50% and earnings per share currently is 1.6 cedis. Dividend growth is 5% per annum and this is expected into the foreseeable future. CBGL’s cost of equity is 15%. The issue cost is 600,000 cedis.

Required:

i) Calculate the market price per share.
(2 marks)

ii) Calculate the capitalization of CBGL.
(2 marks)

iii) Calculate the rights issue price.
(2 marks)

iv) Calculate the theoretical ex-right price.
(2 marks)

v) Calculate the market capitalization after the rights issue.
(2 marks)

c) KAF is a manufacturer of consumer electronics based in Accra, Ghana. KAF finances its investments with a combination of equity and debt. Its equity capital comprises 10 million shares which are currently trading on the stock exchange at GH¢2.55 per share. Its equity beta is 2.1 currently. The return on the risk-free security is 12.5% while the equity risk premium is 10%.

Included in KAF’s debt stock are irredeemable bonds that have a total face value of GH¢10 million while their total market value is GH¢12 million. The annual coupon of the irredeemable bonds is 18% but is paid semiannually.

The directors of the company are considering two new investment opportunities, which are described below:

  • Project 1: This is an expansion project in the consumer electronics manufacturing industry. It involves the setting up of a new factory in the northern part of Ghana. KAF would finance it with existing capital.
  • Project 2: This involves the installation of a new factory to manufacture furniture for export to foreign markets. Although this investment is a completely new line of business, KAF plans to finance it with existing capital. The average equity beta for the furniture manufacturing industry is 1.52 and the average industry capital structure is 60% equity and 40% debt.

It is expected that KAF’s tax rate will remain at 22%.

Required:

i) Compute the cost of capital that should be used as a discount rate for appraising Project 1.
(5 marks)

ii) Compute the cost of capital that should be used as a discount rate for appraising Project 2.
(5 marks)

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  • 6 Marks

FM – NOV 2015 – L2 – Q3c – Islamic Finance

Explain the terms Mudaraba, Musharaka, and Murabaha contracts in Islamic finance.

Explain the following types of contracts:
i. Mudaraba contract (2 marks)
ii. Musharaka contract (2 marks)
iii. Murabaha contract (2 marks)

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