Answer to Question #82479 in Accounting for Abdul

Question

Bank X has Sh. 100M of assets and Sh. 10M of Equity bank. Bank Y has Sh. 100M in assets and Sh. 4Min equity.
Calculate the Equity Multiplier of each bank.

Answer 1

Equity Multiplier is the ration between the Total Assets and Shareholder’ Equity. In simple term, it’s used measure company’s financial leverage which is the technique of using the borrowed capital.

Equity Multiplier=(Total Assets)/Shareholder'equity

It’s used to test the financial strength of the company. The higher ratio indicates that leverage is more whereas the lower ratio indicates the management is either borrowing less capital or non-availability of borrowed capital.

Let us take an example:

Bank X has Sh. 100M of assets and Sh. 10M of Equity Bank. Bank Y has Sh. 100M in assets and Sh. 4M in equity. Calculate the Equity Multiplier of each bank.

Solution:

Bank X has 100M of assets and 10M of equity.

Now putting values in the formula:

EM=100/10

EM=10

Therefore, the Equity Multiplier ratio of bank X is 10:1.

Similarly, for Bank Y

Bank Y has 100M of assets and 4M of equity.

Again, putting into the formula:

EM=100/4

EM = 25

Therefore, the Equity Multiplier ratio of bank Y is 25:1.

This indicates that Bank Y has higher leverage as compared to Bank Y.