Question 26.7: In Problem 26.6, what is the incremental effect of each busi...
In Problem 26.6, what is the incremental effect of each business unit on the total economic capital? Use this to allocate economic capital to business units. What is the impact on the economic capital of each business unit increasing by 0.5%? Show that your results are consistent with Euler’s theorem.
The incremental effect of Business Unit 1 on total economic capital is 60.78. The incremental effect of Business Unit 2 on total economic capital is 27.81.This suggests that 60.78∕(60.78 + 27.81) or 68.61% of economic capital should be allocated to Business Unit 1, and 27.81∕(60.78 + 27.81) or 31.39% to Business Unit 2. The marginal effect of increasing the size of Business Unit 1 by 0.5% is 0.4182. The marginal effect of increasing the size of Business Unit 2 by 0.5% is 0.2056. Euler’s theorem is satisfied because the total economic capital is approximately equal to the sum of 0.4182/0.005 and 0.2056/0.005.