Ameritrade Case Study
Cost of Capital at Ameritrade
1) Briefly describe the project that Ameritrade is considering
In order to maintain its competitive edge in the discount brokerage market, Ameritrade is considering making major investment state of the art technology that can prevent system outages and guarantee 100% reliability. The new system would enable Ameritrade to follow its mission of becoming the largest brokerage firm based on the number of trades. As part of the project the firm would also invest in a new marketing campaign to promote its improved services and capabilities.
The company would invest $100 million in the technology enhancements and $155 million in marketing during 1998-99 (up from $14 million in 1997). To increase the trade volume, the company is also considering reducing commissions for all internet market orders by more than 70%.
2) The title suggests that the cost of capital is important here. Concisely describe what cost of capital means. It is the cost of what to whom? Why is it important? What factors determine the cost of capital?
Cost of capital is the cost of funds used for financing a business. Cost of capital depends on the mode of financing used – it refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt.
The Cost of Capital is important as the cost of capital represents a hurdle rate that a company must overcome before it can generate value, it is extensively used in the capital budgeting process to determine whether the company should proceed with a project. In other words, the cost of capital for a company represents expected return from alternative (and similarly risky) investments, if the company were to deploy its capital for different investments.
The underlying driver for a company’s cost of capital is the riskiness of its business. The riskier the business (as measured by the risk in assets and revenues), the higher the cost of capital of the
1) Briefly describe the project that Ameritrade is considering
In order to maintain its competitive edge in the discount brokerage market, Ameritrade is considering making major investment state of the art technology that can prevent system outages and guarantee 100% reliability. The new system would enable Ameritrade to follow its mission of becoming the largest brokerage firm based on the number of trades. As part of the project the firm would also invest in a new marketing campaign to promote its improved services and capabilities.
The company would invest $100 million in the technology enhancements and $155 million in marketing during 1998-99 (up from $14 million in 1997). To increase the trade volume, the company is also considering reducing commissions for all internet market orders by more than 70%.
2) The title suggests that the cost of capital is important here. Concisely describe what cost of capital means. It is the cost of what to whom? Why is it important? What factors determine the cost of capital?
Cost of capital is the cost of funds used for financing a business. Cost of capital depends on the mode of financing used – it refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt.
The Cost of Capital is important as the cost of capital represents a hurdle rate that a company must overcome before it can generate value, it is extensively used in the capital budgeting process to determine whether the company should proceed with a project. In other words, the cost of capital for a company represents expected return from alternative (and similarly risky) investments, if the company were to deploy its capital for different investments.
The underlying driver for a company’s cost of capital is the riskiness of its business. The riskier the business (as measured by the risk in assets and revenues), the higher the cost of capital of the