Finance Seminar 12.12.2011 Case Study #2 Ameritrade Company Cost of Capital Evaluation Executive Summary The Ameritrade case study analysis brought in this paper comes to estimate the final cost of capital that should be applied to Ameritrade’s technology and marketing investment project. Allegedly, the final purpose of every WACC calculation is in helping to estimate the NPV of a project in order to make a “go\no go” decision, whether it is done by an investor or a creditor. However such a decision requires also the computation of future cash flows. Since we are missing the information regarding Ameritrade’s future cash flows, this paper has one and only goal – to evaluate and discuss the main possible alternatives for …show more content…
However, we have to consider Ameritrade’s upcoming investment of 255,000,000$ in technology and advertising and the ways Ameritrade is going to finance this investment. The best scenario is finding the optimal capital structure by using interest coverage ratio table but, unfortunately, we do not have enough sufficient data. Ameritrade plans to make an investment which is 1\3 of its total value. By any standards, this is a very significant amount For Ameritrade. Ameritrade’s balance sheet for 1997 shows that the firm has ~ 53.5$m in cash reserves, which might be considered as possible financing source. The firm’s net income for that same year is much lower and equals to ~13.8$m. The implications are that minor fluctuations in Ameritrade’s cash flow might result in negative net income next year and therefore we conclude that Ameritrade should not use its cash reserves for its planned investments in order to prevent cash flow crunch scenarios. Another option is to finance the project by issuing equity, however at that stage we can’t examine this option based on the available data. That been said and without the ability to find the optimal capital structure, we believe that the whole amount of the planned investment should be financed by bonds issuance. Thus, the interest-bearing debt for our calculations will be 255,000,000$. Beta of debt Since Ameritrade has no current traded debt, it
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (Eds.). (2011). Essentials of corporate finance (7th ed., Rev.). New York, NY: McGraw-Hill Irwin.
At the new WACC of 19%, the home appliance and agricultural machinery projects are valued based on their inherent levels of risk. The beta of the industry average home appliance project is 0.95, whereas the beta for the industry average agricultural machine project is calculated as 0.88. CAPM was then employed to find the cost of capital of each project. The cost of capital for the home appliance and agricultural machinery projects were found to be 10.4% and 9.92%, respectively (Appendix B). This analysis allows Star Company to allocate funds to projects that create returns greater than the industry cost of capital for each specific project.
Our estimated cost of capital, 20.81%, is lower than Ricketts’ expected return, 30%-50%, thus the investment is worthy. However, it’s higher than other pessimistic members’ expected return, 10%-15%, making the decision more complex and requiring further valuation。
EEC calculated the amount of time involved the anticipation of its cost ($3 million). The timeline in recovering their cost of investment ($2 million) initially for the foundation of this investment any profit made in the future of this investment will be justified as a profit for the company. If EEC can anticipate a fast return on its investment it is a profitable wise decision in making the investment financial, it is considered to be an easier way of formulating investments financially. On the basis of one year all cash flows is added together equal to the sum of $2 million originally invested, then it is divided by the annual cash flow of $500,000. The calculation of the payback period would equal four years. After this time frame any financial proceeds will be considered profitable for the company. I conclude that the timeframe is adequate in comparison of the investment in this worthwhile investment financial venture for the company.
This paper consists of several sections. The description of the project outlines the capital asset decision at hand, which in this case is the purchase of a new Boeing 787-9 Dreamliner by American Airlines. The second section of the paper highlights some of the information about the Dreamliner. Statistics about seat configuration are critical to the revenue projects used later in the net present value (NPV) calculation. The third section of the paper covers the lease or buy decision. American has both options and this section covers some of the financial aspects of each that are critical, such as depreciation. The fourth section is an explanation of the weighted-average cost of capital for American Airlines. The fifth section is an outline of the NPV calculation. The final section is the conclusion. The NPV compares directly the incremental cash flows associated with the lease option and those associated with the buy option. The final NPV figures are close to one another, but one option clearly adds more value to the company to the other. The "buy" option is therefore recommended.
Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.
The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).
A key factor in determining a project's viability is its cost of capital [WACC]. The estimation of Boeing's WACC must be consistent with the overall valuation approach and the definition of cash flows to be discounted. Note that this process is a forward looking focus and is laden with uncertainty. It is how the assumptions are modeled that many costly mistakes can be made. While finding a rate of return for an individual project, it is important to remember that WACC is only appropriate for an individual project.
Kd (Wd), Ke (We) and Kp (Wp) are the costs (weights) associated, respectively, with the firm’s interest bearing debt,
Historic Average Total Annual Returns on US Government Securities and Common Stocks (1929 - 1996) Average Annual Return Standard Deviation T-Bills 3,8% 3,3% Intermediate Bonds a 5,4% 5,8% Long Term Bonds b 5,5% 9,2% Large Company Stocks c 12,7% 20,3% Small Company Stocks d 17,7%
Generally, firms can choose among various capital structures in order to maximize overall market value of the company. It is proposed however, that
The company’s objective is to improve its competitive position in deep-discount brokerage. In order to achieve this objective, the company must grow its customer base, requiring an investment of $100 million to upgrade its technological capabilities as well as an increase of $155 million for its advertisement budget. In order to evaluate the company’s cost of capital, we used the Cost Asset Pricing Model. Since the company went public recently, it would not be an accurate assessment of the risk of
In this analysis we will investigate the financial condition and economic environment of Amazon.com, Inc., and the online retail goods industry, to assess and assign an appropriate weighted average cost of capital (WACC) for the firm. This analysis will examine each component of capital funding through the lens of multiple models, and consider the validity and sensitivity of each underlying lever. Lastly, this analysis will calculate a risk-appropriate cost of capital to be used in an enterprise firm valuation.
The course project involved developing a great depth of knowledge in analyzing capital structure, theories behind it, and its risks and issues. Before I began this assignment, I knew nothing but a few things about capital structure from previous unit weeks; however, it was not until this course’s final project that came along with opening
This case study focuses on where financial theory ends and practical application of the weighted average cost of capital (WACC) begins. It presents evidence on how some of the most financially complex companies and financial advisors estimated capital costs and focuses on the gaps found between theory and application. The approach taken in the paper differed from their predecessors in several various respects. Prior published information was solely based on written, closed-end surveys sent to a large number of firms, without a focused topic. The study set out to see if financial theory, specifically cost-of-capital, is truly ubiquitous in true business applications.