Leverage, Cost of Capital and Bank Valuation
20 Pages Posted: 2 May 2016 Last revised: 9 Oct 2019
Date Written: September 6, 2016
In this paper we present a model that demonstrates the effect of debt on cost of capital and value for banks with risky assets. Using a static partial equilibrium setting, both in a steady state and steady growth scenario, we derive a bank- specific valuation metric which separately attributes value to assets and debt cash flows in the form of a liquidity premium and a tax-shield. The asset side model proposed does not require the assumption of stable capital structure, typical of the currently applied DCF equity side methods. Furthermore, the theoretical framework we present is helpful in reconciling asset and equity side approaches in banking.
Keywords: bank, capital structure, cost of capital, core deposits
JEL Classification: D58, G21, G31, G32
Suggested Citation: Suggested Citation