Ameritrade provides online brokerage services and operates an Internet-based financial management services business. 90% of the company’s revenues are from the provision of discount brokerage services.
The company’s objective is to improve its competitive position in deep-discount brokerage. In order to achieve this objective, the company must grow its customer base, requiring an investment of $100 million to upgrade its technological capabilities as well as an increase of $155 million for its advertisement budget. In order to evaluate the company’s cost of capital, we used the Cost Asset Pricing Model. Since the company went public recently, it would not be an accurate assessment of the risk of the investment to find the beta of this short time period. Therefore, we chose a similar company called Charles Schwab, which has very similar sources of revenue, discount brokerage services. However, this company has a very different capital structure, so we unleveraged the beta in order to get the best, most accurate beta for Ameritrade. We assumed that the capital structure of Ameritrade did not have debt, and that the project would be financed with equity only. We found a levered beta for Charles Schwab of 2.15. After unlevering it, we got a beta of 1.8768. When using the CAPM model, we concluded that the cost of capital of Ameritrade is equal to 20.40%.
Factors to be considered in evaluating the project
Various factors must be considered by the management of Ameritrade when evaluating the proposed strategies. It is necessary to determine the cost of capital that should be employed for Ameritrade. An appropriate discount rate is required to derive the net present value (NPV) of the investment. NPV is the preferred decision criterion when deciding whether a firm should accept an investment. The NPV indicates how much value the investments ads to the firm and therefore the firm should accept projects with a positive NPV.
It is necessary to consider current as well as future potential strategies adopted by Ameritrade’s key competitors and determine what impact these strategies may have on Ameritrade. The market for discount brokerage services, particularly electronic brokerage services is a new rapidly evolving and intensely competitive market with few barriers to entry. Ameritrade encounters direct competition from approximately 100 other discount brokerage firms, many of which provide electronic brokerage services. These competitors include discount brokerage firms such as Charles Schwab & Co., Inc., Fidelity Brokerage Services, Inc., National Discount Brokers Group, Inc., Quick & Reilly, Inc., and E*Trade Group, Inc. Ameritrade has seen increased competition since 1997 and expects this to continue and intensify in the future. It is expected that Ameritrade’s competitors will also adopt strategies of price-cutting, similar to those proposed by Ameritrade.
Ameritrade, as a result of operating in the discount brokerage market, is currently impacted by significant trends that may affect its financial conditions and thus the results of its operations. Commissions charged to customers of discount brokerage services have steadily decreased over the past several years, and this is expected to continue. This has had a negative impact on Ameritrade’s per trade commission and clearing fee revenue but has resulted in increased account activity and an overall increase in commission and clearing fee revenue. The development of technology and increased use of electronic mediums is expected to decrease operating expenses per trade.
Since Ameritrade’s revenues are derived from the securities brokerage business, they may be directly affected by economic and political conditions as well as changes in volume and price levels of securities transactions. An economic downturn adversely affects the firm’s trading volumes and subsequently its net revenues, negatively affecting...