Question

A bank has book value of $5 million in liquid assets and $95 million in nonliquid assets. Large depositors unexpectedly withdraw $9.5 million in deposits. To cover the withdrawals the bank sells all of its liquid assets at book value. To raise the additional funds needed the bank sells the necessary amount of nonliquid assets at 80 cents per dollar of book value. As a result, the bank's equity will _____________.

Answer 1

Answer:

The equity will reduce by $1,125,000 or 1.125 M

Explanation:

Liquid assets needed to mange the withdraw = Withdrawal amount - Existing Liquid asset

Liquid assets needed to mange the withdraw = $9,500,000 - $5,000,000

Liquid assets needed to mange the withdraw = $4,500,000

Required Sale of Non-liquid assets = Liquid assets needed to mange the withdraw  / Ratio of sale to book value

Required Sale of Non-liquid assets = $4,500,000 / 80%

Required Sale of Non-liquid assets = $5,625,000

Change in Bank Equity = Required Sale of Non-liquid assets -  Liquid assets needed to mange the withdraw

Change in Bank Equity = $5,625,000 - $4,500,000

Change in Bank Equity = $1,125,000

The equity will reduce by $1,125,000 or 1.125 M