Cost of Capital at Ameritrade

Only available on StudyMode
  • Download(s) : 428
  • Published : August 13, 2010
Open Document
Text Preview
Harvard Business School

Rev. April 26, 2001

Cost of Capital at Ameritrade
In mid-1997, Joe Ricketts, Chairman and CEO of Ameritrade Holding Corporation, wanted to improve his company’s competitive position in deep-discount brokerage1 by taking advantage of emerging economies of scale. The success of the strategy required Ameritrade grow its customer base. The growth would require substantial investments in technology to improve service and capacity, and in advertising, to increase customer awareness. The strategy would require large expenditures relative to Ameritrade’s existing capital. In order to evaluate whether the strategy would generate sufficient future cash flows to merit the investment, Ricketts needed an estimate of the project’s risk.

Company Background
Formed in 1971, Ameritrade has been a pioneer in the deep-discount brokerage sector. Not only did Ameritrade help create the deep discount market, but it also was the first to offer many new services that changed the way individual investors managed their portfolios. Ameritrade, for example, was the first to offer automated touch-tone phone trading (1988), online internet trading2 (1994), a personal digital assistant to access trades (1995), and online program investing for individual investors (1996). The average return on equity during 1975 to 1996 was 40%, as all years, except two, posted a positive return. Recent returns on equity were much higher, with each of the most recent five years having larger returns than the 40% average. In March 1997, Ameritrade (NASDAQ: AMTD) raised $22.5 million in an initial public offering allowing the company to continue its long tradition of adopting the latest advances in technology, and to substantially increase advertising to build its brand and improve market share.

1 Deep-discount brokers offer no-frills execution of equity and fixed income transactions for a minimal fee. 2 In 1995 Ameritrade acquired K. Aufhauser & Company which in 1994 launched the first internet trading site.

Professors Mark Mitchell and Erik Stafford prepared this case with the assistance of Research Associates Jose Camacho and Aldo Sesia as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2000 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. 1


Cost of Capital at Ameritrade

Revenue Sources
Exhibit 1 displays Ameritrade’s income statement for the fiscal years 1995-1997 and Exhibit 2 presents the balance sheet for 1996 and 1997. Ameritrade’s two primary sources of revenue were from transaction and net interest. Transaction revenues consisted of brokerage commissions, clearing fees, and payment for order flow, which were cash payments received by Ameritrade for routing orders to execution agents. Interest revenues were generated by charging customers on debt balances maintained in brokerage accounts and the investment of customers’ cash segregated in compliance with federal regulations in shortterm marketable securities. Interest revenues were offset by interest payments to customers based on credit balances maintained in brokerage accounts. Virtually all of Ameritrade’s revenues were directly linked to the stock market. Investors generally curtailed trading activity and their borrowing in response to sustained downward movements in the stock market. For example, trading activity declined more than 20% in 1988 following the stock market crash of October 19, 1987. A substantial decline in...
tracking img