The following tables show the balance sheets of two banks: East Bank and West Ba

Question

The following tables show the balance sheets of two banks: East Bank and West Bank.___________is a levered bank, while_________is an unlevered bank. Assume that both banks offer an annual rate of 2% on checking deposits and charge an annual rate of 4% on loans. For West Bank, the annual interest cost on deposits is and    the    annual return on loans is Hence, West Bank earns a net profit of, which represents a rate of return of on stockholders equity. For East Bank, the annual interest cost on deposits is, and the annual return on loans is Hence, East Bank earns a net profit of ,which represents a rate of on stockholders'equity. Suppose that the value of loans in both banks declines by 10%. The amount of loans outstanding for East Bank decreases from $450,000 to, which represents a loss of of stockholders' equity. The amount of loans outstanding for West Bank decreases from $200,000 to,  which represents a loss of of stockholders' equity. Therefore_________provides a higher rate of return to its investors, and___________exposes its investors to greater risk in the event of a decline in the value of loans.

Explanation / Answer

the firm which has more debt than equity called levereged. here east bank is levered while west bank is not.

for west bank interest cost @2% of 0 is 0. and return on loan @4% on 200,000 = 8000 so net profit =8000. return of 208,000/200,000= 4%

for east bank interest cost@2% of 500,000=10000. annual return @4% of 450,000=18000. profit of 8000. rate of return of 18000/100000=18%

value decreases by 10% so value is 90%0f 450,000=405,000. so stake holders equity decreases by45000. loss of 45000/100000=45%. west bank decreases 90%of 200,000=180,000. share holders loss of 20000 i.e. 20000/200000=10% so west bank offers high rate of return while east bank exposes its customer at risk

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