1. Briefly describe the project that Ameritrade is considering. Ameritrage wants to be the largest brokerage firm worldwide based on the number of trades. In order to grow the customer base the company would require substantial investment in technology and advertising. These investments are made to improve service, capacity and customer awareness of Ameritrade.
2. The title suggests that the cost of capital is important here. Concisely describe what cost of capital means. It is the cost of what to whom? Why is it important? What factors determine the cost of capital? The cost of capital is the opportunity cost of funds - debt and equity – to the company while undertaking a project. It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet. He factors that determine the cost of capital are risk free rate, risk premium and beta asset for the project.
3. Ameritrade has a short history of trading, so its equity beta cannot be computed precisely using its own historical data. Exhibit 4 provides some choices for comparable firms. Which of these firms do you think are appropriate to use as comparables to determine the beta of Ameritrade’s planned advertising and technology investments? Why? Even though the project will invest in advertising and technology, but these investments will bolster Ameritrade’s position in the deep-discount brokerage market and from this market the company will generate all its revenues. And thus we should not use an internet firm as a comparable twin for beta calculation. Ameritrade wants to be a leader in deep-discount brokerage. Other firms in similar business with are Charles Schwab, E*Trade, Quick & Reilly and Waterhouse Investors. Charles Schwab, E*Trade and Quick & Reilly have very low debt to value ratio and majority of their revenue is coming from brokerage. Also Charles Schwab and E*Trade have...
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