Cost of Capital at Ameritrade

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Case Study of Cost of Capital at Ameritrade 1-a How can the CAPM be used to estimate the cost of capital for a real business investment decision? CAPM results can be compared to the best expected rate of return that investor can possibly earn in other investments with similar risks, which is the cost of capital. Under the CAPM, the market portfolio is a well-diversified, efficient portfolio representing the non-diversifiable risk in the economy. Therefore, investments have similar risk if they have the same sensitivity to market risk, as measured by their beta with the market portfolio. So, the cost of capital of any investment opportunity equals the expected return of available investments with the same beta. This estimate is…show more content…
Then we noticed that in exhibit 4, the period of historical data is from 1992-1996. However , the stock of Waterhouse Investor Srvcs only last to Sep 1996, in order to compare the data in the same time horizon, we select the period of 5 years, started from Sep 1991 to Sep 1996. We use ri=(Pt-Pt-1+Dt)/Pt-1 to calculate the monthly return rate of stocks. When the stock split, ri= (x/y*Pt-Pt-1+x/y*Dt)/Pt-1 We chose VW portfolio of NYSE, AMEX, and NASDAQ rather than EW of NYSE, AMEX, and NASDAQ because the value-weight portfolio can reflect the real market situation better. We use the equation ri=(Pt-Pt-1+Dt)/Pt-1 to calculate the monthly return of stock of Charles Schwab Corp, Quick & Reilly Group and Waterhouse Investor Srvcs. Then we have two methods to calculate the Beta of Equity for each company. The first method is using equation COV(Ri,Rm)/Var(Rm) to get the Beta. Then we use BAsset=E/(E+D)*BE+D/(E+D)*BD to calculate the Beta of Asset. We assume that the debt of these companies is risk free, because debt represents only a small fraction of the firm’s value. Here are the answers: | COV (Ri,Rm) | Var Rm | Beta | D/V | E/V | Asset Beta | Charles Schwab | 0.001899719 | 0.000746187 | 2.545901945 | 0.08 | 0.92 | 2.342229789 | Quick & Reilly | 0.001902394 | 0.000746187 | 2.549486932 | 0.00 | 1 | 2.549486932 | Waterhouse Investor Services | 0.002690693 | 0.000746187 | 3.605922579 | 0.38 |

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