LOAN ANALYSIS As a senior loan officer at MC Bancorp, you have the following loan applications waiting for review. The bank uses Altman's Z score, default probabilities, mortality rates, and RAROC to assess loan acceptability. The bank's cost of equity (the RAROC benchmark) is 9 percent. The bank's loan policy states that the maximum probability of default for loans by type is as follows: Loan Type and Maturity AAA-rated A-rated Maximum Allowable Default Probability 0.50% 1.25 Which loans should be approved, and which rejected? 2. An AA-rated, one-year CI loan from a firm with the following financial statement information (in millions of dollars): Cash Accounts receivables Assets Liabilities and Equity $ 40 120 Accounts payable Notes payable $ 55 60 210 Accruals Long-term debt 70 550 1,100 $1,470 Equity (ret. earnings = $200) 735 Total liabilities and equity $1,470 Inventory Plant and equipment Total assets Also assume sales = $1,250 m, cost of goods sold = $930 m, and the market value of equity is equal to 2.2 times the book value. MC Bancorp uses the Altman's Z score model to evaluate AA-rated loans. 3. An A-rated corporate loan with a maturity of three years. A-rated corporate loans are evaluated using the mortality rate approach. A schedule of historical defaults (annual and cumulative) experienced by the bank on its A-rated corporate loans is as follows: Loan type A-rated corporate loans Annual default Cumulative default Years after Issuance 1 year 2 years 3 years 4 years 0.10% 0.25% 0.40% 0.65% 0.10 0.325 0.595 1.858 4. A $2 million, five-year loan to a BBB-rated corporation in the computer parts industry. MC Bancorp charges a servicing fee of 75 basis points. The duration on the loan is 4.5 years. The cost of funds for the bank (the RAROC benchmark) is 8 percent. Based on four years of historical data, the bank has estimated the maximum change in the risk premium on the computer parts industry to be approximately 5.5 percent. The current market rate for loans in this industry is 10 percent.