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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 $60 million and has been allocated economic capital of $400 million. The bank's cost of equity (hurdle rate) is 12%. Using the economic value added (EVA) approach with risk capital as the capital charge base, what is the unit's EVA?

EVA is $12 million. Net income of $60 million less a capital charge of $48 million (12% of $400 million allocated economic capital) leaves $12 million of value created above the shareholders' required return.

  1. A$12 millionCorrect
  2. B$48 million
  3. C$60 million
  4. D-$12 million

Explanation

Capital charge = 12% x $400m = $48m. EVA = $60m - $48m = $12m. The $48m option is just the capital charge, and $60m ignores the charge for capital. A negative $12m reverses the subtraction.

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