Case analysis "Cost of Capital at Ameritrade"
Cost of capital refers to the maximum rate of return a company must earn from its investments, so that the market values of the company’s equity shares do not go down. The people at Ameritrade are not in agreement on the best estimate of the cost of capital. Research analyst put the cost of capital at 12%, while other members of the management estimate it to be at 9% and the CFO estimates it to be at 15%. The CEO of the company is optimistic that the rate of return is greater than the cost of investments. However, it will be difficult to continue with the project without agreeing on the estimate of the cost of capital. Determining the company’s cost of capital is essential for both capital budgeting and capital structured planning decision. Cost of capital can be classified as either implicit cost or explicit cost. Implicit cost is the rate of return associated with forgone opportunities attributed to investments on other projects. Explicit cost is the discount rate that equates to the present value the funds that the company receives from net underwriting costs. In order for the company to determine the average cost of capital, it is essential to consider the cost of each method of financing. This will be useful for the company since the profitability of the project will be judged on the basis of the cost of the sources for financing the project. This provides a composite cost of capital which is inclusive of all the costs of capital such as equity shares and other forms of loans. Cost of capital is an extremely crucial factor in making any financial decision for a company. In order to ensure there is adequate earning for the shareholders which is essential for maintaining present value. The company should ensure that the fund provided through different sources such as loans are at the very least equal to the effective interest rate payable to them. If the company earns less than the effective interest rate,...
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