Question

The financial information of BIT Bank and NAT Bank is shown as follows: BIT Bank (in millions) Assets Reserves Loans $48 Deposits $360 Bank Capital Liabilities $340 $68 NAT Bank (in millions) Assets Reserves Loans $48 Deposits $360 Bank Capital Liabilities $400 $8 Assume that both BIT Bank and NAT Bank have the same net profit after tax of $8 million. a. Calculate for each bank, BIT Bank and NAT Bank, its: i. return on assets (ROA); ii. return on equity (ROE); and iii. leverage ratio. Show all your calculations. 7 marks b. With reference to your answers in 5(a), which Bank (Bank BIT or Bank NAT) is more attractive for shareholders? Show your calculations to explain your answers. 5 Marks C. Which bank (Bank BIT or Bank NAT) is riskier in case of loan depreciation at $60 million? Explain. Show your calculations to explain your answers. 6 marks

Answer 1

For BIT Bank:

Return on Assets = Net Income / Total Assets = 8 / (360 + 48) = 1.96%

Return on Equity = Net Income / Average Equity = 8 / 68 = 11.76%

leverage ratio = Total Asset / Equity = (360 + 48) / 68 = 6

For NAT Bank:

Return on Assets = Net Income / Total Assets = 8 / (360 + 48) = 1.96%

Return on Equity = Net Income / Average Equity = 8 / 8 = 100%

leverage ratio = Total Asset / Equity = (360 + 48) / 8 = 51

b. The NAT Bank is more attractive to the share holders because it generates a high Return on Equity and share holders are the part of the equity.

c. The NAT is more risky in case of loan depreciation becasue it has very less amount of equity to absorb the loss occured.

Here, the loan is depreciated by $ 60 mn.

So, for BIT bank, total assets = $ 360 + 48 - 60 = $ 348

Total Liability is also to be $ 348. Since the equity capital is the forst to absorb any losses, remaining equity = 68-60 = $ 8 and Deposits = $ 340

For NAT bank, total assets = total liabilities = $ 348 mn

But the amount of equity is not anough to cover up the losses incurred. Hence, the probability of bankruptcy is more in the case of NAT.

Since, the risk is more, it is also providing more return.