CFS CLASS 04M M Fakhrul Islam

PROFIT VS INTEREST

1) First Revelation (Surah al-Rum, verse 39)

And whatever you give for interest to increase within the wealth of people will not increase with Allah. But what you give in Zakah, desiring the countenance of Allah - those are the multipliers.

2) Second Revelation (Surah al-Nisa', verse 161)

And [for] their taking of usury (interest) while they had been forbidden from it, and their consuming of the people's wealth unjustly. And we have prepared for the disbelievers among them a painful punishment.

PROFIT VS INTEREST

3) Third Revelation (Surah Al 'Imran, verses 130-132)

O you who have believed, do not consume usury, doubled and multiplied, but fear Allah that you may be successful.

And fear the Fire, which has been prepared for the disbelievers.

And obey Allah and the Messenger that you may obtain mercy.

PROFIT VS INTEREST CONT’D

4) Fourth Revelation (Surah al-Baqarah, verses 275-281)

Those who consume interest cannot stand [on the Day of Resurrection] except as one stands who is being beaten by Satan into insanity. That is because they say, "Trade is [just] like interest." But Allah has permitted trade and has forbidden interest. So whoever has received an admonition from his Lord and desists may have what is past, and his affair rests with Allah. But whoever returns to [dealing in interest or usury] - those are the companions of the Fire; they will abide eternally therein.

Allah destroys interest and gives increase for charities. And Allah does not like every sinning disbeliever.

Indeed, those who believe and do righteous deeds and establish prayer and give zakah will have their reward with their Lord, and there will be no fear concerning them, nor will they grieve.

PROFIT VS INTEREST CONT’D

O you who have believed, fear Allah and give up what remains [due to you] of interest, if you should be believers.

And if you do not, then be informed of a war [against you] from Allah and His Messenger. But if you repent, you may have your principal - [thus] you do no wrong, nor are you wronged.

And if someone is in hardship, then [let there be] postponement until [a time of] ease. But if you give [from your right as] charity, then it is better for you, if you only knew.

And fear a Day when you will be returned to Allah. Then every soul will be compensated for what it earned, and they will not be treated unjustly.

PRACTICE AND EXAM

1. Which of the following correctly describes the balance sheet of a firm?a) Current assets and current liabilities are on the right-hand side of the balance sheet. Fixed

assets, long-term liabilities, and equity are on the left-hand side.

b) Current assets, current liabilities, and equity are on the right-hand side of the balance sheet. Fixed assets and long-term liabilities are on the left-hand side.

c) Current assets and fixed assets are on the left-hand side of the balance sheet. Current liabilities, fixed liabilities, and equity are on the right-hand side.

d) Current assets, fixed assets, and equity are on the left-hand side of the balance sheet. Current liabilities and long-term liabilities are on the right-hand side.

2. Which of the following statements is true?a) Depreciation is a noncash deduction.

b) Net income is the same as cash flow to stockholders.

c) Net additions to NWC is the same as cash flow from assets.

d) Both A and C are true.

Answer

3. Calculate net income based on the following information.Sales = $150.00Cost of goods sold = $90.00Depreciation = $15.00Interest paid = $20.00Tax rate = 34%

a) $16.50

b) $26.40

c) $34.60

d) $39.60

4. From the following income statement information, calculate Oswald's after tax cash flow from operations.Net sales = $ 2,000Cost of goods sold = $ 850Operating expenses = $ 395Depreciation = $ 248Tax rate = 34%

a) $755.00

b) $1,150.00

c) $582.62

d) $977.62

Answer

5. Steeperton plc is committed to maximising the wealth of its shareholders.

Given this objective, which one of the following methods of investment appraisal is most appropriate for the company to use?A Net present valueB Internal rate of returnC Payback periodD Accounting rate of return

6. You would like to buy a new automobile. You have $50,000 or so, but the car costs $68,500.

If you can earn 9 percent, how much additional money do you have to invest today to buy the car in two years?

A $57,655.08B $7,655C $68,500 D $8,655

Answer

7. A company is considering a project for investment which will cost $70,000 now and another $10,000 in year five. The company has a cost of capital of 8%. The project has the following discounted cash flows:

What is its discounted payback period in years and months (to the nearest month)?

A 2 years, 10 monthsB 3 years, 1 monthC 3 years, 3 monthsD 3 years, 6 months

Year Discounted cash flows$

1 23,1482 30,0073 19,8464 14,701

Answer

8. The net present value of a proposed project is a positive $56,000 at a discount rate of 10% and a negative $28,000 at 20%.

What is the internal rate of return of the project, to the nearest whole percentage?A 17%B 13%C 30%D 8%

9. Statement 1: Simple payback period takes into account the time value of money and uses cash flows rather than profits.Statement 2: Internal rate of return takes into account the time value of money and uses cash flows rather than profits.Which of the above statements is/are true?

A Statement 1 onlyB Statement 2 onlyC Both statement 1 and statement 2D Neither statement 1 nor statement 2

Answer

10. Sonoran Co recently evaluated an investment project that had an initial cash outlay followed by positive annual net cash flows over its life. The company employed the internal rate of return (IRR) and discounted payback period (DPP) methods for the investment appraisal. Later, it was discovered that the cost of capital figure used was incorrect and that the correct figure was higher.

What will be the effect on the IRR and DPP of correcting for this error?

Answer

Effect onIRR DPP

A No change No changeB Increase IncreaseC Decrease DecreaseD No change Increase

11. Maia plc is considering investing in two competing projects: Delta and Gamma. Delta has a net present value (NPV) of $16,500 and an internal rate of return (IRR) of 17%. Details of the estimated cash flows of Gamma are as follows:

The business has a cost of capital of 10%.

Which one of the following combinations is correct concerning the NPV and IRR of the two projects?

$000Cash flowsYear 0 (200)Year 1 120Year 2 60Year 3 80

Delta GammaA Higher NPV Higher IRRB Higher NPV Lower IRRC Lower NPV Higher IRRD Lower NPV Lower IRR

Answer

12. The following statements about the drawbacks of the accounting rate of return (ARR) were

made at a recent meeting:

1. ARR is based on accounting profits and not cash flows, and can change because profits are subject to

different possible treatments.

2. ARR only considers cash flows within a given time period and ignores cash flows after that time

period.

3. With the ARR method $1 receivable today is worth the same as a $1 in five years. Therefore it ignores

the time value of money.

Which combination of the above statements is true?

A 1, 2 and 3

B 1 and 2 only

C 1 and 3 only

D 2 and 3 onlyAnswer

13. A single, overall cost of capital is often used to evaluate projects because:a. It avoids the problem of computing the required rate of return for each Investment proposal.b. It is the only way to measure a firm's required return.c. It acknowledges that most new investment projects have about the same degree of risk.d. It acknowledges that most new investment projects offer about the same expected return.

14The weighted average cost of capital for a firm is the:

a. Discount rate which the firm should apply to all of the projects it undertakes.

b. Rate of return a firm must earn on its existing assets to maintain the current value of its stock.

c. Coupon rate the firm should expect to pay on its next bond issue.

d. Maximum rate which the firm should require on any projects it undertakes.

e. Required rate which every project's internal rate of return must exceed.

Answer

15. Peter’s Audio Shop has a cost of debt of 7%, a cost of equity of 11%, and a cost of preferred stock of 8%. The firm has 104,000 shares of common stock outstanding at a market price of $20 a share. There are 40,000 shares of preferred stock outstanding at a market price of $34 a share. The bond issue has a total face value of $500,000 and sells at 102% of face value. The tax rate is 34%. What is the weighted average cost of capital for Peter’s Audio Shop?

a. 6.14%

b. 6.54%

c. 8.60%

d. 9.14%Answer

16. If the CAPM is used to estimate the cost of equity capital, the expected excess market return is equal to the:

a. Return on the stock minus the risk-free rate.

b. Difference between the return on the market and the risk-free rate.

c. Beta times the market risk premium.

d. Beta times the risk-free rate.

Answer

17. Betas may vary substantially across an industry. The decision to use the industry or firm beta: to estimate the cost of capital depends on

a. how small the estimation errors are of all betas across industries.

b. how similar the firm's operations are to the operations of all other firms in the industry.

c. whether the company is a leader or follower.

d. the size of the company's public float.Answer

18. Which one of the following statements is correct concerning the weighted average cost of capital (WACC)?

a. The WACC may decrease as a firm's debt-equity ratio increases.

b. When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate multiplied by the par value of the stock.

c. A firm's WACC will decrease as the corporate tax rate decreases.

d. The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share.

Answer

19. Cameron Industries is expected to pay an annual dividend of $1.30 a share next month.

The market price of the stock is $24.80 and the growth rate is 3 percent. What is the

firm's cost of equity?a. 7.58 percent

b. 7.91 percent

C. 8.24 percent

d. 8.40 percent

Answer

20. The Sealing Company has 1,500 bonds outstanding that are selling for $1,060 each. The

company also has 5,000 shares of preferred stock at a market price of $32 each. The

common stock is priced at $26 a share and there are 36,000 shares outstanding. What is

the weight of the common stock as it relates to the firm's weighted average cost of

capital?

a) 6 percent

b) 35 percent

c) 41 percent

d) 54 percent

Answer

21. To compute the required rate of return for equity in a company using the CAPM, it is necessary to know all of the following EXCEPT:

a. The risk-free rate.

b. The beta for the firm.

c. The earnings for the next time period.

d. The market return expected for the time period.

Answer

22. In calculating the costs of the individual components of a firm's financing, the corporate tax rate is important to which of the following component cost formulas?

a. Common stock.

b. Debt.

c. Preferred stock.

d. None of the above.

Answer

ANSWER FOR MCQ

Question no Answer Question no Answer

1 C 12 C

2 A 13 A

3 A 14 B

4 C 15 D

5 A 16 B

6 B 17 B

7 C 18 A

8 A 19 C

9 B 20 B

10 D 21 C

11 D 22 B