Ameritrade

DUO YANG

U0727827

Cost of Capital at Ameritrade

1. How can the Capital Asset Pricing Model be used to estimate the cost of capital for a real (not financial) investment decision?

If a firm tend to invest in a business, the cost of capital define the minimum rate of return the company must earn on existing assets to meet the expectations of its capital providers. We can also use the CAPM to estimate this minimum required rate of return, and then get a risk-free rate suitable for evaluating average risk investments undertaken by a firm.

2. What is the estimate of the risk-free rate and the market risk premium that should be employed in calculating the cost of capital for Ameritrade?

From Exhibit 3,

The risk-free rate = 6.61% (30-year bonds)

The risk premium is equal to the annual return on common stocks reduces that on government stocks.

The risk premium (1950-1996)= 14.0% (large company stocks)- 6% (the annual return on government stocks)= 8%

The risk premium (1929-1996)= 12.7% (large company stocks)- 5.5% (the annual return on government stocks)= 7.2%

3. In principle, what are the steps for computing the asset beta in the CAPM for purposes of calculating the cost of capital for a project?

Cost of equity capital = Interest rate on government bond + ( (Historical excess return on common stocks)

We can treat ( as a factor reflecting the risk of Ameritrade’ shares relative to that of average share. We can use the data to figure out the slope of the line, and the slope is the beta.

4. Ameritrade does not have a beta estimate as the firm has been publicly traded for only a short time period. Exhibit 4 provides various choices of comparable firms. What comparable firms do you recommend as the appropriate benchmarks for evaluating the risk of Ameritrade’s planned advertising and technology investments?

I recommend that use Charles Schwab Corp, E*Trade, Quick & Reilly Group...