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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A firm has three business units. Unit A has expected profit of USD 30 million and allocated economic capital of USD 200 million. Unit B has expected profit of USD 18 million and allocated capital of USD 100 million. Unit C has expected profit of USD 12 million and allocated capital of USD 60 million. Using return on risk-adjusted capital (expected profit divided by economic capital), which unit ranks highest and what is its ratio?

Unit C ranks highest with a return on risk-adjusted capital of 20 percent, computed as 12 divided by 60. Unit B earns 18 percent and Unit A 15 percent. Ranking by absolute profit would wrongly favor Unit A, because it ignores the capital consumed.

  1. AUnit A at 15.0%
  2. BUnit B at 18.0%
  3. CUnit C at 20.0%Correct
  4. DUnit B at 12.0%

Explanation

A: 30/200 = 15%. B: 18/100 = 18%. C: 12/60 = 20%. Unit C is highest. Ranking by absolute profit would wrongly favor Unit A.

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