A note on the implications of mudarabah for capital budgeting decisions

The central economic problem is dealing with law of scarcity and the fact that resources are limited. An Islamic economy is different from a conventional one in that Islamic economic actors do not have complete freedom. While scholars have copiously addressed the problems of riba (interest), they have devoted less attention to the consequences of adopting a profit-and-loss-sharing approach. Capital budgeting deals with the ideal allocation of resources. The main conventional framework used for capital budgeting is the net present value (NPV) model. Interest rates are central to the NPV model -- future returns are discounted based on these rates. A mudaraba arrangement is one where an investor's funds are put toward a venture managed by a mudarib for the sake of earning and subsequently sharing profits. Business risk is shared in a mudaraba setting. This is a desirable method of capital budgeting because it yields spiritual benefits and avoids many of the ills of the interest s