CFS CLASS 04

M 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

CONTD

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

CONTD

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)

b)
c)
d)

2.

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.
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.
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.
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.

Which of the following statements is true?

a)
b)
c)
d)

Depreciation is a noncash deduction.

Net income is the same as cash flow to stockholders.
Net additions to NWC is the same as cash flow from assets.
Both A and C are true.
Answer

3. Calculate net income based on the

following information.
Sales = $150.00
Cost of goods sold = $90.00
Depreciation = $15.00
Interest paid = $20.00
Tax rate = 34%

a)
b)
c)
d)

$16.50
$26.40
$34.60
$39.60

4. From the following income

statement information, calculate
Oswald's after tax cash flow from
operations.
Net sales = $ 2,000
Cost of goods sold = $ 850
Operating expenses = $ 395
Depreciation = $ 248
Tax rate = 34%
a)
b)
c)
d)

$755.00
$1,150.00
$582.62
$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 value
B Internal rate of return
C Payback period
D 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 $57,655.08
B $7,655
C $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:
Year
Discounted cash flows
$
1
23,148
2
30,007
3
19,846
4
14,701
What is its discounted payback period in years and months (to the nearest month)?
A 2 years, 10 months
B 3 years, 1 month
C 3 years, 3 months
D 3 years, 6 months
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 only
B Statement 2 only
C Both statement 1 and statement 2
D 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?
Effect on
A
B
C
D

IRR
No change
Increase
Decrease
No change

DPP
No change
Increase
Decrease
Increase
Answer

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:
$000
Cash flows
Year 0
Year 1
Year 2
Year 3

The business has a cost of capital of 10%.

(200)
120
60
80

Which one of the following combinations is correct concerning the NPV and IRR of
the two projects?
A
B
C
D

Delta
Higher NPV
Higher NPV
Lower NPV
Lower NPV

Gamma
Higher IRR
Lower IRR
Higher IRR
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 only
Answer

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. Peters 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
Peters 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

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