Project Investment Decision Is Being Presumed Around August 1997

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Ameritrade went public only from March 1997, and this project investment decision is being presumed around August 1997. In the initial phase of a publicly-traded company, the stock return can be extremely volatile and difficult to estimate. This also presents a challenge that we cannot accurately calculate an equity beta (βE or βL) due to lack of sufficient historical data for variances and the expected return based on statistical tools. In such a scenario, we seek to use the data from similar companies within the same industry. It is prudent to use the data of companies that have similar capital structure, size, investments and business operations. In particular, the discount brokerage firms seem to have striking similarity in…show more content…
While, E*Trade is akin to Ameritrade in its current business and capital structure, it should be excluded from the analyses, as (i) it does not have enough historical stock data (its only about 12-months since it went public and its small dataset may be unreliable) and (ii) its volatile stock return data did not show any significant regression relationship with the NYSE market returns (ANOVA p-value = 0.11, Appendix-I). Therefore, it is more appropriate to estimate Ameritrade’s return (RE) and βL based on the average industry risk of the ‘pure play’ discount brokerage firms, Charles Schwab, Quick & Reilly, and Waterhouse. Estimating RWACC for Ameritrade based on stock and debt information of similar firms In order to calculate RWACC for Ameritrade, we need to estimate its RE, RD, D/V, E/V ratios and corporate tax rate. E(RE ) can be calculated using the CAPM method, for which we need Rf, E(RM), and the βL. We used the following assumptions and methods to obtain βL for Ameritrade. (1) Capital Asset Pricing Model (CAPM): This model says that the expected return of a security or a portfolio is equivalent to the rate on the risk-free security plus a risk premium. If the expected return does not meet or exceed the required return, the investment should not be made. We used this CAPM to estimate the cost of capital for Ameritrade. The CAPM formula is Ri = Rf + βi* (RM-Rf) where Rf = the rate of return for a risk-free security, RM = the
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