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Valuation: Measuring and Managing the Value of Companies, Sixth Edition
Chapter 34 Banks
Solutions
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
2. The value drivers of the equity cash flow model are interest rates, volumes, cost-to-income ratio,
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 the higher
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, which is what could
have been earned on comparable investments in the market (e.g., corporate bonds of similar
maturity and risk). An increase in the maturity spread can lower the after-tax economic spread by
increasing the tax penalty (TP) on equity:
Req Eq Cap
2
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 flows and lowers the
cost of capital. Since there is not an explicit tax shield benefit from the interest paid on deposits, it
might seem that changing the ratio of deposits to equity (i.e., debt to equity) would not affect the
