1. Case study Ameritrade
Cost of capital

2. Cost of capital Ameritrade
• Introduction to the case
• Calculate CAPM
• Calculate WACC

3. Company Background
• Ameritrade is forms in 1971
• Pioneer in the deep-discount brokerage
• In Mar 1997, Ameritrade raised $22.5 million in IPO

4. CAPM – Capital Asset Pricing Model
• Ke = Rf + B ( Rm – Rf)
• Risk free rate
• Beta
• Expected market return
• Market risk premium (Rf-Rm)

5. CAPM
Risk free rate
- Using 30-years bond
• Rf = 6.61%
Why?
• Ameritrade is going to make a substantial investment in technology
• Ameritrade’s mission is to be the largest brokerage firm worldwide.
Thus, long-term investment
Exhibit 3 Capital Market Return Data
(Historical and Current)
Prevailing Yields on U.S. Government Securities (August 31,
1997)
Annualized Yield to
Maturity
3-Month T-Bills 5.24%
1-Year Bonds 5.59%
5-Year Bonds 6.22%
10-Year Bonds 6.34%
20-Year Bonds 6.69%
30-Year Bonds 6.61%

6. CAPM
Market risk premium
Ameritrade is a large company
• Historic average total returns on US government securities and common
stocks.
• Rm = 14%
Ameritrade is a large company
• 1997, Ameritrade raised 22.5
Million in IPO
Historic Average Total Annual Returns on U.S. Government
Securities and Common Stocks (1950-1996)
Average Annual
Return
Standard
Deviation
T-Bills 5.2% 3.0%
Intermediate Bondsa 6.4% 6.6%
Long-term Bondsb 6.0% 10.8%
Large Company
Stocksc 14.0% 16.8%
Small Company
Stocksd 17.8% 25.6%

7. CAPM
Market risk premium
Rm (1959-1996) = 14%
Rf (30 year treasury) = 6.61%
Market risk premium = 14% - 6.61% = 7.39%

8. CAPM
Unlevered beta
• Average return price, compared to; VW, NYSE, and NASDAQ from Aug-31-
1997 to Aug-31-1992 => x-value, km (%) and y-value Ks(%) => regression
• Beta asset, Charles = .92/(.92+.08))*1.40+(.,08/(.08+.92))*(1-.35)= 1.40
• Beta asset, Quick & Reilly = 1.87
• Beta asset, Waterhouse = 2.23
• Average of the three beta asset = 1.83%
Charles Schwab Coefficients Standard Error
Intercept -0.00280594 0.017640836
X Variable 1 1.40430709 0.486186341

9. CAPM
Risk free rate (30 years bond) = 6.61%
Market risk premium (1950-1996) = 14% - 6.61% = 7.39%
Ameritrade Beta = 1.83
Ke = 6.61% + 1.83 (14% - 6.61%)
= 20.13%

10. WACC – Weighted Average cost of capital
• WACC is the cost of capital of the company.
• WACC is the rate that a company is expected to pay back to
shareholders.

11. WACC
WACC = E/ D+E* (Re) + D/D+E* (Rd) (1-t)
• E = market value of equity
• D = Market value of debt
• Re= Cost of equity
• Rd = Cost of debt
• T = corporate tax

12. Debt/Value Debt/Capital
(Market Values) (Book Values)
Firm Name (Industry) Current
Average
1992-1996 Current
Average
1992-1996
Bear Stearns (Investment Services) 0.60 0.50 0.69 0.60
Charles Schwab Corp (Discount Brokerage) 0.05 0.08 0.25 0.30
E*TRADE (Discount Brokerage) 0.00 NA 0.00 NA
Mecklermedia (Internet) 0.00 0.00b 0.00 0.00b
Quick & Reilly Group (Discount Brokerage) 0.00 0.00 0.00 0.00
Raymond James Financial 0.05 0.04 0.07 0.06
Waterhouse Investor Srvcs (Discount
Brokerage) NA 0.38 NA 0.70c
Market Value of Debt/Equity

13. Debt and value ratios
Comparable
Date Firm Price # share Market cap D/E 1-(D/V)
29-Aug-97
Charles
Schwab 42.75 176,422.00 7,542,040.50 0.08 0.92
29-Aug-97 Quick & reilly 34.25 38,664.00 1,324,242.00 0 0
30-Sep-96 Water house 37.875 11,501.00 435,600.38 0.38 0.62
Total 114.875 226,587.00 9,301,882.88 46.00%154.00%
Average 23.00% 77.00%

14. WACC
Assuming no debt
WACC = (Wd*Rd) + (We*Re*)
= (0.23*0) + (0.77*0.2) = 15.40%
Ameritrade cost of capital = 15.40%