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Valuation: Measuring and Managing the Value of Companies, Fifth Edition
Chapter 36 Solutions
Valuing Banks
1. The reason for using the equity cash flow method for valuing a bank is that the valuation
of operations is not separate from interest revenue and expense. Interest revenue and
expense are major components of a bank’s operational income, and this differs from a
2. The inputs of the equity cash flow model are income, the change in equity from retained
earnings and stock issuance, other comprehensive income, and the cost of equity capital.
The corresponding inputs in the enterprise DCF model are the cash flow from operations,
3. Maturity mismatch means that the maturity of the liabilities does not equal that of the
assets. Usually, the yield curve slopes upward, and banks tend to make long-term loans at
4. The maturity mismatch does not necessarily affect the pretax economic spread. That
spread is simply the rates earned on the loans minus the opportunity cost of the loans,
Opportunity Cost of Deposits]}.
5. The cost of holding equity capital is the so-called tax penalty, whose present value equals
the equity capital times the tax rate. If the capital is invested in a risk-free security such as
6. The retail aspect of banking would probably not offer a lot of opportunity for competitive
advantage. For most loans, borrowers can shop around from bank to bank for the best
7. Although the current loan loss provision is not deducted from the DCF, the future
provisions are deducted from forecasts of future interest income. Making forecasts of
8. The Modigliani and Miller theorem states that the capital structure of a firm will not
influence the value of the firm except if the tax shield on interest expense increases cash
