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.

...6 – FINANCIAL ARCHITECTURE
The problems to estimate the cost of capital
Before starting to describe the problems associated to the estimation of the cost of
capital, it is extremely relevant to describe its meaning: according to Investopedia, it is “the
cost of funds used for financing a business”. In order to carry out this process, the companies
can only be financed through equity; only through debt; or using a “combination of debt and
equity” - in this particular case it is a “overall cost of capital derived from a weighted average of
all capital sources, widely known as the weighted average cost of capital (WACC) (...)”
(Investopedia, 2013). The estimation of the cost of capital depends on several factors, such as
the “operating history, profitability, credit worthiness, etc.”. It means, of course, the most recent
companies will face higher costs of capital because their risk is higher when compared to solid
companies (Investopedia, 2013).
It is now important to describe a few and the most important problems regarding the
estimation of the cost of capital:
(i) Assumptions about the costs of equity and debt: these assumptions deeply affect
“the type and the value of the...

...The Cost of Capital for Goff Computer, Inc.
Rahul Parikh
BUS650: Managerial Finance (MAH1209A)
Dr Charles Smith
March 18, 2012.
The Cost of Capital for Goff Computer, Inc.:
1. Most publicly traded corporations are required to submit 10Q (quarterly) and 10K (annual) reports to the SEC detailing their financial operations over the previous quarter or year, respectively. These corporate fillings are available on the SEC Web site at www.sec.gov. Go to the SEC Web site, follow the “Search for Company Filings” link, the “Companies & Other Filers” link, enter “Dell Computer,” and search for SEC filings made by Dell. Find the most recent 10Q and 10K and download the forms. Look on the balance sheet to find the book value of debt and the book value of equity. If you look further down the report, you should find a section titled either “Long-term Debt” or “Long –term Debt and Interest Rate Risk Management” that will list a breakdown of Dell’s long-term debt.
Answer:
The book value of a company's equity is the same as stockholder's equity, which can be computed by subtracting the total value of liabilities from total assets.
(Total Assets) = (Total) Liabilities + Stockholder's Equity (book value of equity).
Stockholder's Equity (book value of equity) = Total Assets –Total Liabilities.
The book value of the company’s liabilities and equity was found from the site http://www.sec.gov . I found Dell’s...

...is cost of capital?
The cost of capital is the cost of obtaining funds, through debt or equity, in order to finance an investment. 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.
Importance
The concept of cost of capital is a major standard for comparison used in finance decisions. Acceptance or rejection of an investment project depends on the cost that the company has to pay for financing it. Good financial management calls for selection of such projects, which are expected to earn returns, which are higher than the cost of capital. It is therefore, important for the finance manager to calculate the cost of capital, which the company has to pay and compare it with the rate of return, which the project is expected to earn.
In capital expenditure decisions, finance managers go on accepting projects arranged in descending order of rate of return. He stops at the point where the cost of capital equals to the rate of return offered by the project. That is, the finance manager finds out the break-even point of the project. Accepting any project beyond the break-even point will cause financial loss for the...

...Cost of Capital
Definition: cost of capital is the rate of return that a company must earn on its project investments to maintain its market value and attract funds. The cost of capital to a company is the minimum rate of return that is must earn on its investments in order to satisfy the various categories of investors, who have made investments in the form of shares , debentures and loans. Thecost of capital in operational terms refers to the discount rate that would be used in determining the present value of the estimated future cash proceeds and eventually deciding whether the project is worth undertaking or not. It is defined as "the minimum rate of return" that a firm must earn on its investment for the market value of the firm to remain unchanged.
Basic Aspects of concept of Cost of capital :
here are three basic aspects of concept of cost. They are:
* It is not a cost as such.
* It is the minimum rate of return.
* It comprises the following 3 components:
* Return at Zero risk level – This refers to the expected rate of return when a project involves no risk whether business or financial.
* Premium for business risk – The term business risk refers to the variability in operating profit due to change in sales. The concept is...

...ogCost of capital
First of all I would like to say the I wanted to calculate the cost of debt and cost of equity but the information given in the statements are missing the items needed to calculate the cost of debt and the cost of equity but I would like to analyze the information related to this part
The market capitalization already increased in year 2010to 7,016 million from the previous year which was 3,805 million in year2009.also we can see the share price started year2010 with equal to 180,168,300 and ended the year with 143,885,400 this time it’s showing decreasing number not increasing as usual we need to look to the property plant and equipment its percentage increased as it was 69.7% in year 2009 to 70.3% in year 2010,we can have a look to the receivables and prepayments and this was higher in year 2009 with 13% than it was 2010 with 10.4% .the inventories percentage already decreased from year 2009 to 2010 as we see it was 0.2%in year2009 then it became 0.1% .we don’t need to forget about looking to the shareholders equity as it was 3,,641 million in year 2010 and was lower in the year of 2009 with 2,621 million and it was higher in year 2009 than it was in year 2009,the total assets were increased as we see it was 11,398 in year 2009 and it was 13,240 in year 2010 ,when we look to the revenue we can find that it’s as other equities increasing in a great way as it was 3,133million...

...WEIGHTED AVERAGE COST OF CAPITAL FOR DELL COMPUTER
1) From the SEC website, the balance sheet of Dell Computer reveals a
Book value of debt = $3,394,000,000 and
Book value of equity = $4,625,000,000
The same balance shows the breakdown of the long-term debt (book values) in table 1.
Table 1
Coupon Rate
(%) Maturity Book Value
(Face Value in million $)
3.38 06/15/2012 400
4.70 04/15/2013 599
5.63 04/15/2014 500
5.65 04/15/2018 499
5.88 06/15/2019 600
7.10 04/15/2028 396
6.50 04/15/2038 400
2) From finance.yahoo.com,
• The most recent (Oct 30 2009) stock price (Po) = $14.45
• Market value of equity or market capitalisation = $28,260,000000
• Shares outstanding (28,260,000,000/14.45) = 1,955,709,343
• No dividend is paid recently. In this case, the dividend discount model cannot be used
• The three-month treasury bill yield = 0.03%
Cost of Equity
Risk free rate (Rf)= 0.03%
Systematic risk of Equity (Beta, BE) = 1.36
Assuming market risk premium = 8.6%
Using the Capital Asset Pricing Model (CAPM),
Cost of equity (RE) = Rf + BE(RM - Rf)
Where,
RM is expected return on the overall market
(RM - Rf) is the market risk premium
Cost of equity (RE) = 0.0003 + 0.086 x 1.36
= 0.1173 = 11.73%
Therefore, the cost of equity is 11.73%
3) Cost of Debt
From www.nasdbondinfo.com,...

...Cost of Capital
Firms need to make capital investment i.e., purchasing fixed assets such as factories, machineries, equipment, etc. After deciding what capital investments to make, they need to decide on the financing – sources of capital. The sources: Long-Term Debt, Common Stock, Preferred Stock and Retained Earnings. Then they need to find the cost of obtaining each source of financing today (not historical).
Cost of Capital - The rate of return that a firm must earn on its investment projects to maintain its market value and attract funds. It depends on the risk of that investment (use of funds, not source of funds)
1. Cost of Debt (rd) – we use Bonds to represent the cost of long-term debt. Its required rate of return is the yield-to-maturity (YTM) of the bond. After we calculate the rd, we need to find the after-tax cost of debt : rd (after-tax) = rd(1 –T). In finding the YTM, we need to have the bond’s current price. If there is a flotation costs involved in issuing the bond, we need to deduct these costs first to find the net price of the bonds.
(Example: A company wants to sell $10 million worth of 20-year, 9% coupon bonds with a par value of $1,000 each. The firm must sell the bonds for $980 to reflect the market price of other similar bonds. The flotation...

...What’s your real cost of capital?
By James J. McNulty, Tony D. Yeh, William s. Schulze, and Michael H. Lubatkin
Harvard Business Review, October 2002
Issue of the article: valuing investment projects
Number of pages: 12
Daniel Miravet Campos
Part 1. Executive summary
This article is fundamentally based on the exposition of a new method to calculate the cost of capital for a company (MCPM), to meet the inefficiencies of the current one (CAPM).
In valuing any investment project or corporate acquisition, executives of a company must compare the cost that operation would require with its expected future cash flows. To do so, they must discount those future cash flows with a specific rate in order to make the comparison meaningful. This is what we know as cost of equity capital, and determining that discount rate is a very important task for the managers of a company, since applying a too high or too low rate will have significant effects on estimating the project’s or company’s value.
The traditional approach to evaluating capital investments is to apply the capital asset pricing model (CAPM), which has remained practically unchanged for 40 years.
This standard formula states that a company’s cost of capital is equal to the risk-free rate of return plus a premium (historical difference between the...

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