FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement
A bank's commercial lending unit reports net income after tax of $48 million and is allocated economic capital of $400 million. The bank's cost of equity (hurdle rate) is 10%. Using the standard economic value added (EVA) approach, what is the unit's EVA?
EVA is $8 million. The unit earns $48 million but must cover a capital charge of 10% on $400 million, which is $40 million. Subtracting the charge from after-tax income leaves a positive $8 million of value created for shareholders.
- A$8 millionCorrect
- B$40 million
- C$4.8 million
- D$12 million
Explanation
EVA = net income - (capital charge) = 48 - (10% x 400) = 48 - 40 = $8 million. Check: RAROC is 48/400 = 12%, which exceeds the 10% hurdle by 2%, and 2% x 400 = 8. The $40 million option is only the capital charge.
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