Ameritrade Cost of Capital

Ameritrade Cost of Capital

1. Among the various factors Ameritrade should consider are the risk free rate, the market risk premium, and the beta. These are required for calculating the cost of capital. Ameritrade should also consider the long term sustainability of the project. Sustainability of the project is critical to estimating future cash flows. Other factors that should be considered are the state of the economy and the risk of the project.

Additionally, we need to consider the return on investment versus the cost of capital because we want to ensure that the project will add value to the company. Therefore, we need to consider the net present value and the internal rate of return. This will allow us to measure assumptions about project risks and market return which will tell us if the return on investment exceeds the cost of capital and whether or not the investment in technology and advertising is a smart move.

Further, Ameritrade should look at their capital rationing to determine if there are any other projects that they could invest in that would be more profitable for the company. Also the company should only go through with the investment if the expected returns from these projects are more than the stockholders could make on their own if they were to invest it in the market. Thus, they should only invest in technology and advertising if the expected returns from the projects exceed the opportunity cost of capital for the shareholders, because the company would be plowing back this income to reinvest it in the company, instead of paying it out to the shareholders to reinvest the money in whatever they wish. Ameritrade should only go through with these projects if they have a positive NPV and the NPV of this project is greater than the NPV of other possible projects.

1. a. The Average Annual Return from Large Company Stocks from years 1929 – 1996 in Exhibit 3 is the best estimate of the market index,  RM = 12.7% This is used because it is the best estimate for the long term returns on the stock market of large companies.

b. The Average Annual Return of Long Term Bonds from years 1929 – 1996 from Exhibit 3 is the best estimate for the historical Risk Free Rate, RF = 5.5% 

c. The CAPM Risk free rate is the prevailing yields on 10-Year US Government Securities dated August 31, 1997 from Exhibit 3, Rf = 6.34% This is used because it is the best estimate of the current and forward looking risk free rate for the project.

3.   Ameritrade belongs in the deep-discount brokerage sector and had two primary sources of revenue: transaction and net interest. Since nearly all of Ameritrade’s revenues were directly linked to the stock market, comparable firms are discount brokerages.