Cost of Capital at Ameritrade
1) Briefly describe the project that Ameritrade is considering
In order to maintain its competitive edge in the discount brokerage market, Ameritrade is considering making major investment state of the art technology that can prevent system outages and guarantee 100% reliability. The new system would enable Ameritrade to follow its mission of becoming the largest brokerage firm based on the number of trades. As part of the project the firm would also invest in a new marketing campaign to promote its improved services and capabilities.
The company would invest $100 million in the technology enhancements and $155 million in marketing during 1998-99 (up ...view middle of the document...
In practice, the factors affecting cost of capital include capital structure policy, dividend policy, investment policy, level of interest rates and tax rates.
3) Ameritrade has a short history of trading, so its equity beta cannot be computed precisely using its own historical data. Exhibit 4 provides some choices for comparable firms. Which of these firms do you think are appropriate to use as comparables to determine the beta of Ameritrade’s planned advertising and technology investments? Why?
The comparable firm should exhibit similar business fundamentals in terms assets, business model, and risk. As such, we think that other major discount brokerages (Charles Schwab, Quick & Reilly, and Waterhouse) should be used as comparable firms to calculate equity and asset betas.
4) Using the stock price and return data in Exhibits 5 and 6, estimate the CAPM beta
The table below shows the equity betas for the firms presented in the case (using Jan-92 to Dec-96 equal weight NYSE/AMEX/NASDAQ as market portfolio):
After levering the equity beta, the asset beta of the firms are calculated. As mentioned we think that the three discount brokerages (highlighted in green) should be used as comparables for Ameritrade. The average asset beta of the three firms is 1.386. As a comparison the investment services firms have average asset beta of 0.603 and the one internet company...