|1:|| The allocated profit after tax of the corporate banking division is $4 million. An equity of $20 million has been allocated to this profit centre.
Compute the RAROC, the cost of equity and the EP, knowing that the risk-free rate on government bonds is 10% and that the market demands a risk premium of 5% on bank shares.
Golden rule for value creation
Value is created by the corporate banking unit whenever the RAROC of 20% exceeds the cost of equity of 15%, or when the EP of $1 million is positive.