Case ID: 201046     Solution ID: 22200     Words: 2218 Price $ 75

Cost of Capital at Ameritrade Case Solution

Case Solution

Ameritrade Holding Corp. is thinking of a huge marketing and technology funding and investment to enhance the organization’s standing in deep-discount brokerage via benefiting from the rising economies of scale. To assess if the designed plan of action would lead to adequate cash flow in the long term to meet the investment needs, Joe Ricketts, chairman and CEO of Ameritrade, ml for the chalked project. There is substantial debate about computing the cost of capital. A researcher has benchmarked the cost of capital to be equal to 12%, Ameritrade’s CFO estimated the cost of capital at 15%, and a few individuals in the Ameritrade managerial team strongly adhere to the fact that that the borrowing rate should be 9%; this rate should be used to discount the future cashflows that are to be drawn from the project. There is also an ongoing debate regarding Ameritrade’s nature of business. While the management is insistenton Ameritrade being a brokerage firm, some researchers and managers of other internet-based brokerage companies are of the idea that Ameritrade is a technology/Internet company. 

Excel Calculations

Cost of Capital Calculations

Calculating Asset Beta for Ameritrade

Stock Price Data for Comparable Firms & Market

Charles Schwab        NASDAQ

 Date     Shares Price        Adjusted Price       Stock Return           Dividend Stock         Split 

Questions Covered

What factors should Ameritrade management consider when evaluating the proposed advertising program and technology upgrades? Why?

How can the Capital Asset Pricing Model be used to estimate the cost of capital for a real (not financial) investment decision?

What is the estimate of the risk-free rate that should be employed in calculating the cost of capital for Ameritrade?

What is the estimate of the market risk premium that should be employed in calculating the cost of capital at Ameritrade?

In principle, what are the steps for computing the asset beta in the CAPM for the purposes of calculating the cost of capital for a project?

Ameritrade does not have a beta estimate because the firm has been publicly traded for only a short time period. Exhibit 4 provides various choices of comparable firms. What comparable firms do you recommend as the appropriate benchmarks for evaluating the risk of Ameritrade’s planned advertising and technology investments?

Using the stock price and returns data in Exhibits 4 and 5, and the capital structure information in Exhibit 3, calculate the asset betas for the comparable firms.

How should Joe Ricketts, the CEO of Ameritrade, view the cost of capital you have calculated?