Cost of Capital at Ameritrade

Fama and French’s three factor model attempts to explain the variation of stock prices through a multifactor model that includes a size factor and BE/ME factor in addition to the beta risk factor. Fama-French model essentially extended the CAPM (which breaks up cause of variation of stock price into systematic risk which is non-diversifiable and idiosyncratic risk which is diversifiable) by introducing these two additional factors. Fama and French find that stocks with high beta didn’t have consistently higher returns than stocks with low beta and this indicates that beta was not a useful measure under their model. Their model is based on research findings that sensitivity of movements of the size and BE/ME factor constituted risk, and

The group struggled in choosing riskier stocks because the idea of a risk seemed unattractive. Given this fact, the group immediately looked to the technology industry. In technology there is a constant race to create something new, new innovations, to better the products of competitors. As a result of this, stocks may fluctuate and favors of consumers may shift. One of our first selections was Amazon.com. Amazon is a cloud computing and electronic commerce company that was founded in 1994. As a result of the dramatic increase in popularity of Amazon, from 1.5 million active customer accounts to 305 million in 2015, investing in the stock appeared to be a rational and smart choice, resulting in the groups buying of 10 shares. The company as a whole

After levering the equity beta, the asset beta of the firms are calculated. As mentioned we think that the three discount brokerages (highlighted in green) should be used as comparables for Ameritrade. The average asset beta of the three firms is 1.386. As a comparison the investment services firms have average asset beta of 0.603 and the one internet company (Mecklermedia) for which enough historical data is

They only need to manage the 30+ distributors instead of a larger number of tier 1 customers.

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.

The regression that we performed in excel for both stocks yielded a beta of .73576 for Reynolds, and a beta of 1.4198 for Hasbro. In question 2 we learned that although Reynolds stock was riskier independently, adding it to the portfolio made it more diversified compared to adding Hasbro, due to the fact that it was less correlated to the market portfolio. Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Therefore, since the beta of Reynolds is lower than Hasbro, our beta calculations align with the fact that Reynolds stock makes the overall portfolio less risky. This finding is also intuitive when considering the nature of the companies; Reynolds is a Tobacco company meaning that is should be less sensitive to changes in market conditions than a toy company like Hasbro.

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

What factors should Ameritrade Management consider when evaluating the proposed advertising program and technology upgrades? Why?

To find the asset Beta (βa), we need to find the weighted average β of equity and the weighted average β of debt. We consider the β of debt to be 0, as debt has no relationship with market risk and it is evident from the balance sheet that Ameritrade had no interest bearing debt in 1997[1].

Using the CAPM formula, we can plug in the equity beta for MCI, we can determine

For estimation of betas, the above equation was run for the period from Jan, 2003 to Dec, 2006. Based on the estimated betas we have divided the sample of 63 stocks into 10 portfolios each comprising of 6 stocks except portfolio no.1, 5 and 10 having seven stocks each. The first portfolio 1 has the 7 lowest beta stocks and the last portfolio 10 has the 7 highest beta stocks. The rationale for forming portfolios is to reduce measurement error in the betas.

Using the same market risk premium and risk free rate (5.5% & 4.62% respectively) given in the case, the averaged beta of 1.40, the pretax cost of debt of 7.65%, and the weighted average of debt & equity, the products & systems

In front of Dan Chores is the issue of recommending three hurdle rates for each of Marriott Corporation's three divisions, which have significant effect on the firm's financial and operating strategies as well as its incentive compensation. Marriott Corporation had three major lines of business: lodging, contract services and restaurants. Also Marriott had its growth objective, to remain a premier growth company.

In the analysis, S&P500, an index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors commonly used benchmarks for overall U.S stock market. Consequently, the beta coming from Dow Chemical is more sensitive than eBay to the benchmarks, which implies the security will be expected significantly outperformed market when market is going up and significantly underperformed when market is going down. Dow Chemical is an American multinational chemical corporation, services including agricultural science, consumer solution, infrastructure solutions, performance material & Chemicals, and etc. Being as one of the most influential commodity company, Dow Chemical is affected by the world price of oil as well as its competitors and is also plagued by currency fluctuations since products are exported to all regions of the globe. For example, severe weather on August of 2010, resulting in big power cuts and dramatic drop in whole market especially for commodity industry such as Dow Chemical. In contrast, lower beta means less volatile to the market index, also may have lower returns for investors. eBay is an e-commerce company, which is more rely on the online trading and transactions in the globe. product turns less fluctuate in the whole market, especially compared with current retailer companies, internet retailer

I am interested in examining the size factor for two reasons. Firstly, there has always been disparity with regard to the persistence of the size factor in literature. Secondly, the discussion has a strong practical implication in constructing asset pricing model and determining the cost of capital.