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Suppose Levered Bank is funded with 2% equity and 98% debt. Its current market capitalization is $10 billion, and its market-to-book ratio is 1. Levered Bank earns a 4.22% expected return on its assets (the loans it makes) and pays 4% on its debt. New capital requirements will necessitate that Levered Bank increases its equity to 4% of its capital structure. It will issue new equity and use the funds to retire existing debt. The interest rate on its debt is expected to remain at 4%. a. What is Levered Bank's expected ROE with 2% equity? b. Assuming perfect capital markets, what will Levered Bank's expected ROE be after it increases its equity to 4%?

Suppose Levered Bank is funded with 2% equity and 98% debt. Its current market capitalization is $10 billion, and its market-to-book ratio is 1. Levered Bank earns a 4.22% expected return on its assets (the loans it makes) and pays 4% on its debt. New capital requirements will necessitate that Levered Bank increases its equity to 4% of its capital structure. It will issue new equity and use the funds to retire existing debt. The interest rate on its debt is expected to remain at 4%. a. What is Levered Bank's expected ROE with 2% equity? b. Assuming perfect capital markets, what will Levered Bank's expected ROE be after it increases its equity to 4%?

FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Suppose Levered Bank is funded with 2% equity and 98% debt. Its current market capitalization is $10 billion, and its market-to-book ratio is 1. Levered Bank earns a 4.22% expected return on its assets (the loans it makes) and pays 4% on its debt. New capital requirements will necessitate that Levered Bank increases its equity to 4% of its capital structure. It will issue new equity and use the funds to retire existing debt. The interest rate on its debt is expected to remain at 4%. a. What is Levered Bank's expected ROE with 2% equity? b. Assuming perfect capital markets, what will Levered Bank's expected ROE be after it increases its equity to 4%?
Transcribed Image Text:Suppose Levered Bank is funded with 2% equity and 98% debt. Its current market capitalization is $10 billion, and its market-to-book ratio is 1. Levered Bank earns a 4.22% expected return on its assets (the loans it makes) and pays 4% on its debt. New capital requirements will necessitate that Levered Bank increases its equity to 4% of its capital structure. It will issue new equity and use the funds to retire existing debt. The interest rate on its debt is expected to remain at 4%. a. What is Levered Bank's expected ROE with 2% equity? b. Assuming perfect capital markets, what will Levered Bank's expected ROE be after it increases its equity to 4%?
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