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    Ameritrade Final

    Uploaded by

    Tarek Dandach
    This document discusses calculating the cost of capital for Ameritrade using the CAPM and WACC models. It provides background on Ameritrade and describes the business question of whether to invest in advertising, technology, or cut costs. It then calculates Ameritrade's cost of equity as 26.83% using the CAPM with a risk free rate of 6.61%, beta of 2.736, and market risk premium of 7.39%. Finally, it calculates WACC under two scenarios, finding a cost of capital of 7% if debt has no risk and 19% if debt has some market risk.

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    Ameritrade Final

    Uploaded by

    Tarek Dandach
    612 views24 pages
    This document discusses calculating the cost of capital for Ameritrade using the CAPM and WACC models. It provides background on Ameritrade and describes the business question of whether to invest in advertising, technology, or cut costs. It then calculates Ameritrade's cost of equity as 26.83% using the CAPM with a risk free rate of 6.61%, beta of 2.736, and market risk premium of 7.39%. Finally, it calculates WACC under two scenarios, finding a cost of capital of 7% if debt has no risk and 19% if debt has some market risk.

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    ameritrade finance case

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    This document discusses calculating the cost of capital for Ameritrade using the CAPM and WACC models. It provides background on Ameritrade and describes the business question of whether to invest in advertising, technology, or cut costs. It then calculates Ameritrade's cost of equity as 26.83% using the CAPM with a risk free rate of 6.61%, beta of 2.736, and market risk premium of 7.39%. Finally, it calculates WACC under two scenarios, finding a cost of capital of 7% if debt has no risk and 19% if debt has some market risk.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    612 views24 pages

    Ameritrade Final

    Uploaded by

    Tarek Dandach
    This document discusses calculating the cost of capital for Ameritrade using the CAPM and WACC models. It provides background on Ameritrade and describes the business question of whether to invest in advertising, technology, or cut costs. It then calculates Ameritrade's cost of equity as 26.83% using the CAPM with a risk free rate of 6.61%, beta of 2.736, and market risk premium of 7.39%. Finally, it calculates WACC under two scenarios, finding a cost of capital of 7% if debt has no risk and 19% if debt has some market risk.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 24

    Cost of Capital at Ameritrade

    CAPM

    Cost of Capital at Ameritrade

    Introduction to Case

    Calculate CAPM

    Calculate WACC

    Company Background

    Ameritrade is formed in 1971

    pioneer in the deep-discount brokerage


    sector.

    In Mar 1997, Ameritrade raised $22.5


    million in IPO

    Company Background

    - Source of revenue from Transaction


    and Net interest

    Business Question
    Joe Ricketts (CEO) is thinking cut cost,
    invest in advertise or invest in
    technology
    - Expect return 30-50%
    - Expect return 10-15%
    What type of Ameritrade Business?

    Who are Ameritrades Competitors

    E*Trade

    Waterhouse Investor Service

    Charles Schwab

    Quick & Reilly

    Other Information that we have?

    Ameritrade Annual Income, Balance


    sheet

    Capital Market return data

    Ameritrade & Competitors Stock price

    Stock return from NYSE

    What do we need to answer


    question

    CAPM (Capital Asset Pricing Model)

    WACC (Weighted Average Cost of Capital)

    Risk Free Rate


    Beta (unleverage)
    Risk Premium
    Expected Market Return

    E/V ratio
    Re
    Rd
    D/V

    What do we need to answer


    question
    CAPM (Capital Asset Pricing Model)
    WACC (Weighted Average Cost of Capital)

    CAPM - Capital Asset Pricing Model


    Ke = Rf + B (Rm-Rf)
    Risk free rate
    Beta
    Expect Market return
    Market risk premium (Rm-Rf)

    CAPM - Capital Asset Pricing Model


    Risk free rate
    We pick up 30-years bonds
    Rf = 6.61%
    Why?
    Ameritrade is going to make a substantial investment
    in technology
    Ameritrades mission is to be the largest brokerage
    firm worldwide(Long term investment)

    CAPM - Capital Asset Pricing Model


    Market Risk Premium
    Historic Average Total Annual Returns on US
    government securities and Common Stocks(Exhibit 3)

    We consider Ameritrade is a large company


    - in 1997, Ameritrade(NASDAQ: AMTD) raised 22.5
    million in an initial public offering

    CAPM - Capital Asset Pricing Model


    Historic Average Total Annual Returns on US
    government securities and Common Stocks
    Rm (1950-1996) = 14%
    Rm (1929- 1996) = 12.7%
    Market return Rm = 14% (More recent)
    Market Risk Premium = 14% - 6.61% =7.39%

    CAPM - Capital Asset Pricing Model


    Beta
    Ameritrade is a new list company, we do not have
    enough information about Beta
    Exhibit 4 provides various choices of comparable
    firms:
    Charles Schwab Corp (Discount Brokerage)
    E*Trade (Discount Brokerage)
    Quick & Reilly Group (Discount Brokerage)
    Waterhouse Investor Srvcs (Discount Brokerage)

    CAPM - Capital Asset Pricing Model


    Unlevered Beta
    Charles Schwab
    2.450843913
    Quick Reilly
    2.385245695
    Waterhouse Investor Service 3.372739586
    Average Ameritrade Beta

    2.736276398

    CAPM - Capital Asset Pricing Model


    Risk Free Rate (30 years bond) = 6.61%
    Market Risk Premium (1950-1996) = 14% - 6.61% =7.
    39%
    Ameritrade Beta = 2.736276398

    Ke = Rf + B (Rm-Rf)
    =6.61%+ 2.7 (14% - 6.61%)
    =26.83%

    WACC- Weighted Average Cost of Capital

    Why uses WACC in this


    Case?
    WACC is the cost of capital of the company
    WACC is a rate that a company is expected to pay
    back to both shareholder and debt holders.
    A New investment project should give rate of
    return higher than the cost of capital

    WACC- Weighted Average Cost of Capital

    Find Market Value of Debt/Equity

    WACC- Weighted Average Cost of Capital

    35%

    Assume Rd

    Scenario 1
    Rd = 0
    Assume that debt has no relationship to
    market risk

    Scenario 2
    Rd = 0.25*
    Assume some market-related risk to corporate
    debt

    * Empirical studies of corporate debt returns (ref)

    WACC- Weighted Average Cost of Capital

    Senario 1
    Cost of Capital = 7%
    Senario 2
    Cost of Capital = 19%
    * Empirical studies of corporate debt returns (ref)

    Should the company invest the new


    projects?

    Money that the Company


    need to pay back

    Expected Return of
    the new investment projects

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