Amitrade: a Problem Excercise of Cost of Capital

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MBA 203: Problem Set 4
Cost of Capital at Ameritrade
Due: Wednesday, November 28, 2012, by 9:00 a.m.
The course material covered in weeks 4 and 5 should be sufficient for doing this problem set. The questions below are for the Cost of Capital at Ameritrade case in your course packet. You can find the data for this case on the course website in a spreadsheet named Ameritrade.xls.

Please turn in your problem set solutions by posting them to bSpace as an Excel file or pdf file. Upload a single solution for each group, with all group members listed on the first page. If you turn in an Excel file, make sure the grader can understand what you did without clicking on any cells. To make that possible, please include cells with appropriate explanations of what you did.

This problem set is due by 9:00 a.m. on Wednesday, 11/28. No late assignments will be accepted.

Questions: Assume that the investments under consideration will be financed with equity only (i.e., no debt financing).
1. What estimate of the risk-free rate should be employed in calculating the cost of capital for Ameritrade?
2. What estimate of the market risk premium should be employed in calculating the cost of capital for Ameritrade?
3. Ameritrade does not have a beta estimate since the firm has been publicly traded for only a short time period. Exhibit 4 provides various choices of comparable firms. What comparable firms do you recommend as the appropriate benchmarks for evaluating the risk of Ameritrade’s planned advertising and technology investments? Hints for #3:

• It does not matter what Ameritrade spends its investments on up-front (advertising and technology investments) since these costs are known numbers, and you are calculating the cost of capital to figure out the present value of the projected cash flows from later years. What matters is what beta the firm’s assets will have, where the assets are the subsequent cash flows that Ameritrade gets out of making the up-front investments.

• It is...
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