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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

A bank evaluates two business units using EVA with a 11% cost of equity. Unit A: risk-adjusted net income $44 million, economic capital $300 million. Unit B: risk-adjusted net income $22 million, economic capital $120 million. Which conclusion is correct?

Unit A has the higher EVA ($11 million versus $8.8 million), while Unit B has the higher return on capital (18.3% versus 14.7%). EVA is an absolute dollar measure that scales with capital employed, whereas return on capital is a ratio.

  1. AUnit A has the higher EVA, while Unit B has the higher return on capitalCorrect
  2. BUnit B has the higher EVA and the higher return on capital
  3. CUnit A has the higher EVA and the higher return on capital
  4. DBoth units have identical EVA but different returns on capital

Explanation

Unit A: charge 33, EVA = 11; return 44/300 = 14.67%. Unit B: charge 13.2, EVA = 8.8; return 22/120 = 18.33%. Thus A has higher absolute EVA, B the higher percentage return. A common mistake is assuming the higher ratio implies higher value added in dollars.

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