Case II Ameritrade

29,384
-1

Published on

Ameritrade Cost of Capital Study

Published in: Business, Economy & Finance
0 Comments
6 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
29,384
On Slideshare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
0
Comments
0
Likes
6
Embeds 0
No embeds

No notes for slide

Case II Ameritrade

  1. 1. Cost of Capital By: Hammed Adeniyi Gabriela Nevergold Kristine Nukk Carlos Walton
  2. 2. <ul><li>Ameritrade management should consider the following factors when evaluating the proposed advertising program and technology upgrades. ------------------------------------------------------------------------------------ </li></ul><ul><li>FUTURE CASHFLOWS </li></ul><ul><li>FUTURE REVENUES </li></ul><ul><li>DEBT TO EQUITY RATIO </li></ul><ul><li>RETURN ON EQUITY / COST OF EQUITY </li></ul>
  3. 3. 2) CAPM use for real (non financial) investment decisions. ------------------------------------------------------------------------- <ul><li>COST OF CAPITAL = OPPORTUNITY COST </li></ul><ul><li>HOW ? CAPM results can be compared to the expected rates of return that investor can possibly earn in other investments with similar risks. </li></ul>
  4. 4. 3) Risk-free rate estimate ------------------------------------------------- <ul><li>10 year U.S. government Treasury bond = 6.34% </li></ul><ul><li>Historical risk-free rate = 6.00% </li></ul>2 OPTIONS
  5. 5. 4) Estimate of the market risk premium. ------------------------------------------------- <ul><li>FACT: Ameritrade is a small cap stock (market capitalization as of August 29, 1997 is 14518*18.813 =273,127). </li></ul><ul><li>DATA: historical average of total annual return on small Company stocks; Rm= 17.8% (1950 – 1996). </li></ul><ul><li>FACT: If we are using historical average of total annual return of small CAP stocks as our market risk, we also have to use historical risk-free premium. For the CAPM method, the historical average return on market should never be used with the current risk-free rate. </li></ul><ul><li>DATA: Rf = 6.0% </li></ul>
  6. 6. <ul><li>CAPM: Steps for computing the asset beta in the CAPM for purpose of calculating the cost of capital for a project. ----------------------------------------------------------- </li></ul><ul><li>Calculate the return of the investment, return on the market.  </li></ul><ul><li>Calculate the standard deviation, variance and covariance of the investments.  </li></ul><ul><li>Use the below formula to solve for the Beta of an asset. </li></ul>
  7. 7. <ul><li>Stock’s monthly returns: </li></ul><ul><li>Considered dividends ((Rt+1 - Rt) - Dt+1) / Rt </li></ul><ul><li>Considered stock splits ((Rt+1 – Rt * St) - Dt+1) / Rt </li></ul><ul><li>Market monthly returns: </li></ul><ul><li>EW NYSE </li></ul><ul><li>AMEX </li></ul><ul><li>NASDAQ </li></ul>
  8. 8. <ul><li>Comparison of 5 years stock and market returns, </li></ul><ul><li>from August 1992 </li></ul><ul><li>to august 1997. </li></ul><ul><li>Beta = 1.53 </li></ul>Double check: Beta =COVAR(Ri,Rm)/VARP(Rm)
  9. 9. <ul><li>Comparison of 1 years stock and market returns, </li></ul><ul><li>from August 1996 </li></ul><ul><li>to august 1997. </li></ul><ul><li>Beta = 1.46 </li></ul>
  10. 10. <ul><li>Comparison of 5 years stock and market returns, </li></ul><ul><li>from August 1992 </li></ul><ul><li>to August 1997. </li></ul><ul><li>Beta = 1.87 </li></ul>
  11. 11. <ul><li>Comparison of 5 years stock and market returns, </li></ul><ul><li>from September 1991 to September 1997. </li></ul><ul><li>Beta = 2.23 </li></ul>
  12. 12. <ul><li>Four comparable discount brokerage firms </li></ul><ul><li>E*Trade eliminated; lack of sufficient public return data </li></ul>
  13. 13. Quick & Reilly Group : Rs = 6.34% + 1.87 (11.8%) = 28.4% Waterhouse Investor Services : Rs = 6.34% + 2.23 (11.8%) = 32.6% RISK FREE RATE (Rf) - 6.34% (10-Year bond) RISK PREMIUM - 11.8% (small cap – long term bond) 1950-1996 Schwab : Rs = 6.34% + 1.53 (11.8%) = 24.4%
  14. 14. Schwab : Debt/Value ratio = 0.08, hence B = .08 Value/Debt ratio = 0.92{1 – 0.05}, hence S = .92 Quick & Reilly Group : Debt/Value ratio = 0.0 Value/Debt ratio = 0.0 Waterhouse Investor Services : Debt/Value ratio = 0.38, hence B = .38 Value/Debt ratio = 0.62 {1 – 0.38}, hence S = .62 Tax rate : 35%
  15. 15. Schwab : Beta asset (I) = (.92/(.92 + .08)) * 1.53 + (.08/(.08+.92))*0 (1-.35) = 1.41 Beta asset (II) = (.92/(.92 + .08)) * 1.53 + (.08/(.08+.92))*0.25 (1-.35) = 1.42 Quick & Reilly Group : Beta asset = n/a Waterhouse Investor Services : Beta asset (I) = (.62/(.62 + .38)) * 2.23 + (.38/(.38+.62))* ))*0 (1-.35) = 1.38 Beta asset (I) = (.62/(.62 + .38)) * 2.23 + (.38/(.38+.62))* ))*0 (1-.35) = 1.44 Tax rate : 35%
  16. 16. Ameritrade Cost of Equity : Rs = 6.34% + 1.877 (11.8%) = 28.49% RISK FREE RATE (Rf) - 6.34% (10-Year bond – 1950-1996) MARKET RETURN (Rm) – 17.0% (Small Company Stock – 1950-1996) RISK PREMIUM - 11.8% BETA (Average of portfolio beta) Beta = (1.53 + 1.87 + 2.23)/3 = 1.877

×