Ameritrade – Cost of Capital

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Group Case 1: Ameritrade – Cost of Capital Executive Summary: As a deep-discount brokerage, Ameritrade planned to improve its competitive position by price cutting, technology enhancements, and increased advertising in mid-1997. Before initiating the plan, Ameritrade needed know whether the investment returned more than it cost. We were hired to estimate the cost of capital correctly. The key question is to find suitable comparable firms to estimate Ameritrade’s asset beta, since it was a recently-listed firm. We thought discount brokerage companies were best due to same revenue resources. Proper risk-free rate and market risk premium should also be chosen carefully, and we used 30-year bonds YTM and the annual return difference…show more content…
Here we choose VW NYSE, AMEX, and NASDAQ data as market returns, because it’s value weighted and more reliable. The results show CSC’s equity beta = 2.27, QRG’s equity beta = 1.79. (2) Estimate asset betas of CSC and QRG. The formula is: βA=DD+EβD+ED+EβE. From Exhibit 4, we find discount brokerage companies less relied on debt. Thus βD’s effect is small and we assume βD = 0. Here we use the current Debt/Value, since market value is more accurate. For CSC: DD+E=0.05. βA=DD+EβD+ED+EβE=0.05*0+0.95*2.27=2.16 For QRG: DD+E=0. βA=DD+EβD+ED+EβE=0*0+1*1.79=1.79 (3) Estimate Ameritrade’s WACC. The average asset beta of CSC and QRG = 1.972. WACC=Rf+avebetaassets*market risk premium = 6.61%+1.972*7.2%=20.81%. 6. Conclusion: 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。 Appendix: Charles Schwab’s adjusted stock price and returns | Date | Adjusted Stock Price | Stock Price | Dividend | Split | Adjusted returns | Rm | 31-Jul-92 | 5.257 | 20.125 | - | | | | 31-Aug-92 | 4.804 | 19.625 | 0.080 | | -0.086294416 | -0.02076 | 30-Sep-92 | 3.843 | 20.125 | - | | -0.2 | 0.01242 | 30-Oct-92 | 4.338 | 21.000 | - | | 0.128762542 | 0.0109 | 30-Nov-92 | 5.329 | 25.375 | 0.080 | | 0.228395062 | 0.04019 | 31-Dec-92 | 5.596 | 24.750 | - | |

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