WEEK 11: CAPITAL STRUCTURE – ISLAMIC PERSPECTIVE PART C

Ronald Rulindo, PhD & Karina Wulandari, SE, MFinMgmt.

Kelas Aplikasi Manajemen Keuangan Islam

Fakultas Ekonomi dan Bisnis – Universitas Indonesia

Background

• Capital structure covers issue on how should the firm raise funds for the selected investments

Source: Ross et.al (2016)

How should the firm raise funds for the selected investments?

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Current Assets

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Fixed Assets

1 Tangible

2 Intangible

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Shareholders’ Equity

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Current Liabilities

Long-Term Debt

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Balance Sheet of Islamic Firm

Pasiva

Shareholders’ Equity

Current Liabilities

Long-Term Debt

Investment Account

Short term Qardh, Murabahah, Salam & Istishna (1< years)

Long term Qardh, Murabahah, Salam & Istishna (1> years)

Mudharabah, Musyarakah, Wakalah

Common Stocks

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Current Assets

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Fixed Assets

1 Tangible

2 Intangible

Aktiva

Aqad:

Stock vs Investment Account?

• As entrepreneur, if you do not want to rise debt-based, which instrument that you prefer?

Stocks

Investment Account

OR

Understanding Stocks

• Stocks represent ownership of investor to the firm / company.
• Investor as shareholders may have control to management of the firm / company (subject to percentages of their ownership).
• Investor will bear the loss of the firm / company during bankruptcy, up to their investment to the company.
• Investor will gain dividend, resulting from a surplus of the net income.
• Net income is generated after deducting revenue with all necessary cost, expenses, and taxes.
• Part of net income can be used as retained earning to promote growth of the company.
• Higher retained earning lead to lower amount of dividend.
• Dividend is usually will be paid every year.
• Original shareholders can lose their firm / company if they stocks or share a diluted frequently.

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Understanding Investment Account

• Investment Account is specific element of Islamic firm / company’s balance sheet.
• Investment Account is a result of Islamic firm / company generate financing or investment based on Mudharabah / Musharakah / Wakalah contracts.
• Financing or Investment in the Investment Account is supposedly in form of muqayyadah (restricted) principle, only for specific investment as agreed by Investors as Investment Account Holders (IAH).
• IAH will generate return from specific projects that they invest in, according to agreed profit sharing ratio (for Mudharabah and Musyarakah), or generate full return after paying ujrah or investment management fees to the firm/company (for wakalah).
• IAH will solely borne the losses of their investment (for Mudharabah and Wakalah) or share the losses with the firm / company according to agreed profit and loss sharing ratio (for Musyarakah).
• Return will be generated periodically (monthly, every quarter, every semester, or every year).
• IAH do not have control to the management of the firm / company.
• Shareholders will lose control or ownership to the firm as the investors only invest in specific projetcs.

Cost of Issuing Stocks (1)

• A part of administrative cost for due process of issuing stocks as required by stock exchanges, there are some additional requirements that have to be fulfilled by firm / company that want to go public, such as have to issue publish annual report and being financially audited by accredited accounting firm.
• For firms that not go to public, procedures for issuing stocks perhaps is simpler, but still have to be legally binding depend of each country’s jurisdiction.
• However, there are some restrictions on how many investors that a firms can have. If it is more than that number, the company oblige to capital market policy issued by financial services authority: either they have to go public using stock exchange platform or using equity crowdfunding platform.

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Cost of Issuing Stocks (2)

• Issuing stock via equity crowdfunding, perhaps is easier and cheaper. But, there is a limited amount of investment that is allowed to be risen using this method.
• There is no obligation to firm / company to provide dividend every year to investors, unless if the stocks are in form of preferred stocks. However, status of preferred stocks to some extend is still debatable among Sharia and Islamic economics scholars.
• However, if the firm / company continuously do not pay dividend, there is huge possibility that the investors will sell stocks of the firms / company, that lead to decrease in stock price of the firms. If this happen, value of the firm would be decreased. It will be difficult for them to generate funding especially in form of stocks the existing shareholders will lose much portion of their ownership if they want to rise more funding.

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Cost of Issuing Investment Account

• Basically, fund in form of Investment account can be generated from various methods:
• Mudharabah / Musyarakah financing from Islamic Financial Services Institutions.
• Mudharabah / Musyarakah or Wakalah financing from individuals or any parties, directly or through specific platform such as equity crowdfunding.
• There would be not many administrative cost for rising fund in form of investment account. Perhaps, it will only in form of legal fees depend on agreement with investors.
• This method, however, is not familiar yet in the business world. Thus, there is possibility of dispute in the case of losses. That’s why, legal agreement as written in the contract is very essential.
• Return will be paid to the IAH periodically. Therefore, cost of financing / investment could be higher than cost of issuing stock / share.
• As IAH bear own risk of their investment, they will demand higher return too as compared to debt-based financing.

Stock vs Investment Account?

• As Investor which instrument that you prefer?

Stocks

Investment Account

OR

Case 1

Peternakan Ayam

• Peternak ayam menghasilkan rata-rata pendapatan sebesar Rp. 50 juta setiap bulan. Dengan seluruh biaya-biaya dikurangnkan, net income yang diperoleh bisa sebesar Rp. 20 juta. Disebabkan Peternak Ayam ini sudah lama beroperasi, ia sanggup mengelola usahanya dengan baik dan pendapatan yang diterima pun telah relative stabil, karena ia sudah memiliki banyak pelanggan tetap. Meskipun demikian, pendapatan tetap bervariasi. Pada kondisi yang tidak menguntungkan, mereka akan memperoleh pendapatan Rp. 30 juta (impas, tidak ada keuntungan).
• Dalam setahun, pendapatan kotor bisa sekitar Rp. 600 juta. Pendapatan bersih sekitar 320 juta.
• Peternak Ayam ingin ingin mendapatkan dana untuk modal sebesar Rp. 300 juta,
• Jika pembiayaan bersifat debt-based, Peternak Ayam harus membayar bunga 10% p.a., yang cicilannya dibayar setiap bulan. Apabila cicilan dibayar terlambat, akan ada penalty 1% dari sisa angsuran setiap bulannya.
• Jika dana yang diperoleh dalam bentuk Anvestment Account, IAH menginginkan nisbah bagi hasil 20:80, dengan 20% keuntungan untuk investor.
• Jika ingin menerbitkan saham, investor menginginkan 30% kepemilikan.
• Jika anda sebagai Peternak Ayam, atau Financial Consultant, pendekatan mana yang anda tawarkan bagi si peternak untuk mendapatkan pendanaan?

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Case 2

Skin Care

• Sebagai pengusaha Skincare, bisnis skin care anda semakin besar. Pendapatan tahunannya saja mencapai Rp. 25 milyar dengan keuntungan bersih sekitar Rp. 10 milyar rata-rata per tahun. Anda ingin menekan biaya Harga Pokok Pembelian dari Skin Care tersebut dengan membuat pabrik sendiri yang diperkirakan bisa menekan biaya produksi, dari tadinya 30% dari harga jual menjadi hanya setengahnya.
• Akant tetapi, anda tidak memiliki cukup dana untuk membangun pabrik, memasang instalasi yang dibutuhkan, hingga merekrut karyawan yang ahli dan terampil. Kurang lebih anda memerlukan Rp. 50 milyar untuk membangun pabrik dengan spesifikasi tersebut. Meskipun demikian, pendapatan bersih anda saat ini saja cukup memadai untuk membayar “bunga” kurang lebih 10% per tahunnya, tetapi anda tidak memiliki asset yang digunakan sebagai underlying dari Sukuk jika anda ingin mendampatkan pendanaan berupa Sukuk, atau pun sebagai jaminan jika anda ingin mendapat kredit dari bank.
• Jika anda ingin mendapatkan pendanaan, berikut kondisi yang harus anda penuhi:
• Saham: Investor menginginkan 50% kepemilikan atas perusahaan anda.
• Project Based Sukuk: Return yang diinginkan investor 15% p.a, dengan akad Ijarah Mausufah Fidzimmah (IMFZ).
• Investment Account: Yang dibiayai adalah perproject skincare, sehingga anda tidak perlu mengeluarkan modal sama sekali (30% dari harga jual) untuk produk anda. Dengan demikian, modal anda dapat anda hemat untuk membangun pabrik dalam 3-5 tahun mendatang. IAH menginginkan bagi hasil 20:80 (20% untuk mereka dari keuntungan).
• Sebagai financial consultant, metode pendanaan mana yang anda akan sarankan?

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Stock Valuation

Discounted Cash-Flow Valuation Technique

Where:

V_j = value of stock j

n = life of the asset

CF_t = cash flow in period t

k = the discount rate that is equal to the investor’s required rate of return for asset j,

The Dividend Discount Model (DDM)

• The value of a share of common stock is the present value of all future dividends

where:

V_j = value of common stock j

D_t = dividend during time period t

k = required rate of return on stock j

The Dividend Discount Model (DDM)

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The Dividend Discount Model (DDM)

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The Dividend Discount Model (DDM)

Suppose a 12% required rate of return with the following dividend growth pattern:

Step 1 – Compute all dividends D₁ … D₈ and D₉

Years 1–2, g = 22%

D₁ = 1.80(1.22) = 2.196�D₂ = 2.196(1.22) = 2.6791

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Years 3–5, g = 18%

D₃ = 2.6791(1.18) = 3.1614�D₄ = 3.1614(1.18) = 3.7304�D₅ = 3.7304(1.18) = 4.4019

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Years 6–8, g = 13%

D₆ = 4.4019(1.13) = 4.9741�D₇ = 4.9741(1.13) = 5.6208�D₈ = 5.6208(1.13) = 6.3515

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Year 9 onwards, g = 7% constant

D₉ = 6.3515(1.07) = 6.7961

Step 2 – Compute terminal value at t = 8

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From year 9 on, dividends grow at a constant 7%, so use the Gordon Growth Model at t = 8:

P₈ = D₉ / (k − g)�P₈ = 6.7961 / (0.12 − 0.07)�P₈ = 6.7961 / 0.05�P₈ ≈ 135.92

So, at t = 8, the shareholder receives:

D₈ ≈ 6.35�Plus the share worth P₈ ≈ 135.92

Step 3 – Discount all cash flows back to t = 0

Now discount the terminal price:

PV(P₈) = 135.92 / (1.12)⁸�PV(P₈) = 135.92 / 2.4760�PV(P₈) ≈ 54.90

Step 4 – Sum all present values

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P₀ ≈ (1.96 + 2.14 + 2.25 + 2.37 + 2.50 + 2.52 + 2.54 + 2.57) + 54.90

P₀ ≈ 18.84 + 54.90

P₀ ≈ 73.74

So, the estimated stock value is:

P₀ ≈ $73.74

PV of Operating Free Cash Flows

• Formula for OCF

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• Similar to the DDM, we can have:
• Constant rate forever
• Assume several different rates of growth for OCF, like the supernormal dividend growth model

Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital

PV of Free Cash Flows to Equity

or

Relative Valuation Techniques

• Provides information about how the market is currently valuing stocks
• aggregate market
• alternative industries
• individual stocks within industries
• No guidance as to whether valuations are appropriate
• best used when have comparable entities
• aggregate market and company’s industry are not at a valuation extreme
• Value can be determined by comparing to similar stocks based on relative ratios
• Relevant variables include earnings, cash flow, book value, and sales

Earnings Multiplier Model

Earnings Multiplier Model

Dividend to Earnings Ratio

Price to Earnings Ratio

Cost of equity

Constant growth

Earnings Multiplier Model

Assume the following information for AGE stock (1) Dividend payout = 50% (2) Required return = 12% (3) Expected growth = 8% (4) D/E = .50 and the growth rate, g=.08. What is the stock’s P/E ratio?

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• What if the required rate of return is 13%

• What if the growth rate is 9%

Earnings Multiplier Model

• In the previous example, suppose the current earnings of $2.00 and the growth rate of 9%. What would be the estimated stock price?
• Given D/E =0.50; k=0.12; g=0.09

P/E = 16.7

• You would expect E₁ to be $2.18

V = 16.7 x $2.18 = $36.41

• Compare this estimated value to market price to decide if you should invest in it

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The Price-Cash Flow Ratio

• Why Price/CF Ratio
• Companies can manipulate earnings, but Cash-flow is less prone to manipulation
• Cash-flow is important for fundamental valuation and in credit analysis
• The Formula

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where:

P/CF_j = the price/cash flow ratio for firm j

P_t = the price of the stock in period t

CF_t+1 = expected cash low per share for firm j

The Price-Book Value Ratio

• Widely used to measure bank values
• Fama and French (1992) study indicated inverse relationship between P/BV ratios and excess return for a cross section of stocks
• The Formula

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where:

P/BV_j = the price/book value for firm j

P_t = the end of year stock price for firm j

BV_t+1 = the estimated end of year book value per share for firm j

The Price-Sales Ratio

• Sales is subject to less manipulation than other financial data
• This ratio varies dramatically by industry
• Relative comparisons using P/S ratio should be between firms in similar industries
• The Formula

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where: P/S_j = the price to sales ratio for Firm j

P_t = the price of the stock in Period t

S_t+1 = the expected sales per share for Firm j

Implementing the Relative Valuation Technique

• First Step: Compare the valuation ratio for a company to the comparable ratio for the market, for stock’s industry and to other stocks in the industry
• Is it similar to these other P/Es
• Is it consistently at a premium or discount
• Second Step: Explain the relationship
• Understand what factors determine the specific valuation ratio for the stock being valued
• Compare these factors versus the same factors for the market, industry, and other stocks

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Combine Step 1 and Step 2.

✅ BUY if:

(A) The stock trades at a DISCOUNT relative to peers,

AND

(B) The fundamentals do NOT justify that discount.

Example:

• INDF trades at P/E 12 while peer average is 16.
• INDF’s fundamentals improving → higher margins, lower debt.
• Market hasn’t priced this yet.

→ Buy signal

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❌ DO NOT BUY if:

(A) The stock trades at a PREMIUM,

AND

(B) There is no strong reason for the premium.

Example:

• A mining company trades at P/E 30 while others trade at P/E 8–10.
• But its reserves are declining, and the commodity cycle is not favorable.

→ Avoid

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