Topic: Islamic Finance

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)