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Question
BALANCE SHEET BIG VALLEY ENTERPRISES
Interest is Big Valley's only fixed cash charge.
Big Valley's market value of equity to book value of debt ratio = 1.5
A bank is using the RAROC to evaluate large business loans. The benchmark rate of return is 7.55%. The 1-year loan interest rate is 8.00% and the bank must pay 7.40% to raise the funds. The cost to service the loan is 0.3%. If the loan defaults, 92% of the money lent will be lost. Based on historical default rates, the extreme worst-case loss scenario is about 5%. Should the bank make the loan? Why or why not?
A. Yes, because the RAROC is 7.11%.
B. No, because the RAROC is 7.11%.
C. Yes, because the RAROC is 6.52%.
D. No, because the RAROC is 6.52%.
E. No, because the RAROC is more than 7.55%.
Answer
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