Using raroc to evaluate large business loans

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Reference no: EM132299407

1. Wells Fargo is using RAROC to evaluate large business loans. The benchmark rate of return is 15%. The one year loan earns 9% and the bank must pay 8.1% to raise the funds. If the loan defaults, 90% of the money lent will be lost. Based on historical default rates, the extreme worst loss case scenario is about 5%. Should the bank make the loan? Give the reason for your answer.

2. Borges Machine Shop, Inc., has a 1-year contract for the production of 250 000 gear housings for a new off-road vehicle. Owner Luis Borges hopes the contract will be extended and the volume increased next year. Borges has developed costs for three alternatives. They are general-purpose equipment (GPE), flexible manufacturing system (FMS), and expensive, but efficient, dedicated machine (DM). The cost data follow: General-Purpose Equipment (GPE) Flexible Manufacturing System (FMS) Dedicated Machine (DM)

Annual contracted units 250000 250000 250 000

Annual fixed cost $ 100 000 $ 250 000 $ 480 000

Per unit variable cost $ 16.00 $ 14.00 $ 13.00

The option GPE is best when the contracted volume is below units (enter your response as a whole number).

The option FMS is best when the contracted volume is between nothing and nothing units (enter your responses as whole numbers).

The option DM is best when the contracted volume is over nothing units (enter your response as a whole number).

Reference no: EM132299407

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