Cost of Capital at Ameritrade

Topics: Rate of return, Finance, Security, Stock, Weighted average cost of capital / Pages: 5 (1067 words) / Published: Sep 28th, 2011
Case Solution
Cost of Capital at Ameritrade
| | • Executive summary:
Formed in 1971 and listed in March 1997, Ameritrade has been one of the most successful players in the deep- discount brokerage sector. Ameritrade’s two major sources of revenue, Transaction income (brokerage commissions, clearing fees, and payment for order flow) and Net interest revenues that were generated from net balance of customers’ brokerage accounts and the investment of customer’s cash segregated in compliance with federal regulations in short term marketable securities contributes over 90% of its revenue.
The company management is now proposing huge capital spending projects on advertising (estimate spending is $155M) and technology enhancements (estimated spending is $100M). Now the company is assessing the reasonableness of the investment, mainly considering the estimate internal return rate comparing with the weighted average cost of capital. The key factor will be the WACC, the higher rate of WACC, the higher risk for the investment.
Based on our assessment which detail stated as below, we learnt that the cost of capital for Ameritrade is very high (around 25%) based on the assumptions we used, hereby we rate the investment risk at high level.
Key assumptions used:
- Long term investment for program life between 10 to 20 years;
- Using market comparable companies’ data to calculate Ameritrade’s beta
- Small listed company • Calculation of WACC 1. Source for the cash of the spending for the proposed projects. a. Increasing debt for the project financing. This will significant reduce the cost of capital but will increase risk of cash flows remaining for stockholders because the safest cash flows went to the debt holders. Also, as a company with high market risk (variable competitors), and low net current assets (risk for the debt return), it is not easy to finance

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