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Analysis Ameritrade
Analysis Ameritrade
Ameritrade needs a cost of capital to evaluate new projects. Firms maximize their value by
taking all positive NPV projects.
E CFi
NPV i 0,1, 2, ...
i 1 r
* i
If Ameritrade analysts use a discount rate that is too high, good projects may be
rejected. If they use a discount rate that is too low, bad projects may be accepted.
Also the Ameritrade analysts should consider, that their company’s internal discount
rate was often used as 15%, but some managers felt appropriate the rate of 8-9%. At
this time, the external discount rate, used by Credit Swiss First Boston was 12%.
So actually computing the NPV earlier, Ameritrade analysts accepted only the best projects
which fitted their high requirements. Now at the end of our analysis, we see that
Ameritrade has a cost of capital close to 19.5%.
Therefore, we can't say for certain whether we will accept the project. We will need the team
to actually re-evaluate the profitability, the cash flow from the project and discount all using
this 19.5% rate to find the NPV, then we can have a solid conclusion.
2. What is the estimate of the risk-free rate RF that should be used in calculating
the cost of capital for Ameritrade?
In our opinion, we should use the risk-free rate equal to yield of 20-year US government
securities, because it is long-term capital investment. We may use 30-year rate, but we are
investing in technology, and concerning the speed of technological enhancements, 20-year
rate is optimal. So it is 5.50%.
3. What is the estimate of the market risk premium, RM RF , that should be used
in calculating the cost of capital for Ameritrade?
Let us agree that Charles Schwab is a comparable firm. Their price changes,
dividends, and stock split information for 1992-1996 is in Exhibit 5. If there were no
stock split, the return, compared to the previous period, is given by:
Pt Pt 1 Dt
Rt . For example, if the price the previous period was $100, then went
Pt 1
up to $104, and in addition had a dividend of $8, the return would be +0.12, or 12%.
In a short time period, the returns will be much closer to 0.
If there is an x for y stock split, use the formula:
x x
Pt Pt 1 Dt
y y
Rt . To make calculating this efficient, we can set x and y equal to
Pt 1
1 for those periods when there is not a stock split, then we can just use the second
formula.