Cost of Capital Ameritrade Case Solution

1. For what purposes does Mortensen estimate Midland's cost of capital? What would be the potential consequences of a too high estimate compared to the firm's “true” cost of capital? What about a too low estimate?

III. The higher the standard deviation, the less certain the rate of return in any one given year.

According to Aswath Damodaran equity risk premium in the US in 1979 was 6.45%, thus

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.

An analyst believes the probability that U.S. stock returns exceed long-term corporate bond returns over a 5-year period is based on personal assessment. This type of probability is best characterized as a(n) ____________.

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。

In the 1920s, American economy had a great time. The vast majority of Americans in 1929 foresaw a continuation of the dizzying economic growth that had taken place in most of the decade. However, the prices of stock crested in early September of 1929. The price of stock fell gradually during most of September and early October. On “Black Tuesday” 29 October 1929, the stock market fell by forty points. After that, a historically great and long economic depression started and lasted until the start of the Second World War. The three causes of the Great Depression are installment buying, uneven distribution of wealth and the irrational behavior in the stock market.

When investing in a company, the goal is to buy shares at a low price and then sell them at a higher price. Individual stocks may go up or down independent of how “The Market” is doing overall. Stock market indices such as the Dow Jones Average, the NASDAQ, and the Standard and Poors 500 report how “The Market” is doing “on average.” To check

I take the “Long –Term U.S. Government Bond Returns from 1926-1987” as appropriate risk free rate from Exhibit 4. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time. “Long –Term U.S. Government Bond Returns from 1926-1987” are include the whole lifetime of Marriot and are more or less risk free.

1-a How can the CAPM be used to estimate the cost of capital for a real business investment decision?

Markets are places which people come together to trade stuffs, and stock market is an exchange where investors come together to buy and sell shares of publicly-treaded companies. (“The Financial Importance of the US Stock Market”) It’s good for our society in a great many ways, but it also can be harmful since people’s desire of money are fully exhibited in stock market. The Great Crash, happened in 1929, was not the event of one day but a series of events stretched initially across the week from October 23 through October 31. (Klein 326) This crisis had seriously impacted the U.S. by losing nearly 90 percent of the value of the stock market at that time. (Bierman) However, different from other events happened in the history, both government and normal people tended to blame the speculators at that time and avoid further investigations of it, but is the cause

In the 1920’s the U.S. economy was booming. The value of stocks were rising and being bought. People were buying tons of stocks. They put as little as ten percent in. Then everything started tumbling down and people lost about ten times as much as they put in.

B. U.S. Treasury bills provided a positive rate of return each and every year during the period. C. Inflation equaled or exceeded the return on U.S. Treasury bills every year during the period. D. Long-term government bonds outperformed U.S. Treasury bills every year during the period. E. National deflation occurred at least once every decade during the period. 18. Which one of the following categories of securities had the highest average return for the period 19262010? A. U.S. Treasury bills B. large company stocks C. small company stocks D. long-term corporate bonds E. long-term government bonds 19. Which one of the following categories of securities had the lowest average risk premium for the period 1926-2010? A. long-term government bonds B. small company stocks C. large company stocks D. long-term corporate bonds E. U.S. Treasury bills 20. Which one of the following categories of securities has had the most volatile returns over the period 1926-2010? A. long-term corporate bonds B. large-company stocks C. intermediate-term government bonds D. U.S. Treasury bills E. small-company stocks

First time this phenomenon was presented by the economists Rajnish Mehra and Edward Prescott in 1985. They discovered that the return from US equity investments in comparison to the return from a risk free government securities had been much far above during the twentieth century to be interpreted by the traditional economic theories (Siegel and Thaler, 1997).

The benchmark year used is 1935 and calculated using weights from their 1935 historical cost capital stock . The weights and benchmark stocks are shown below in Table 4. One may object to the benchmark year used on the grounds that the economy did not reach full capacity until 1942, but using 1940 or 1942 would distort estimates with wartime investment. When geometric rates are used age-price and age-efficiency profiles coincide and therefore, as do PCS and NCS.