The Person DL is the CEO of the Company LST has debt financing concerns. The Company LST uses temporary debt rather than permanent or long-term debt. The person wonders the reason of using debt sources for financing and its impact on the value of stocks. Due to this, the person raised some question to the assistant which was hired recently. To determine: The value of V, s, r and WACC for firm U and L.

Question

National Bank currently has $500 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is decreasing this requirement to 8 percent. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts all excess reserves to loans, but borrowers return only 50 percent of these funds to National Bank as transaction deposits. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts 75 percent of its excess reserves to loans and borrowers return 60 percent of these funds to National Bank as transaction deposits.

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Chapter 21, Problem 2MC

1.

Summary Introduction

Case summary: The Person DL is the CEO of the Company LST has debt financing concerns. The Company LST uses temporary debt rather than permanent or long-term debt. The person wonders the reason of using debt sources for financing and its impact on the value of stocks. Due to this, the person raised some question to the assistant which was hired recently.

To determine: The value of V, s, r and WACC for firm U and L.

b.

Summary Introduction

To draw: A graph showing relationship between capital cost and leverage and also relationship between value of the firm and debt.

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National Bank currently has $500 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is decreasing this requirement to 8 percent. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts all excess reserves to loans, but borrowers return only 50 percent of these funds to National Bank as transaction deposits. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts 75 percent of its excess reserves to loans and borrowers return 60 percent of these funds to National Bank as transaction deposits.

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