Analysis of Cost of Capital at Ameritrade

Analysis of Cost of Capital at Ameritrade

Executive Summary The CEO of Ameritrade, Joe Ricketts, is looking to invest a whopping US$ 155,000,000 increasing the marketing budget and US$ 100,000,000 in technology enhancements. As such, he must justify this investment by proving that the investment is worthwhile. In order to evaluate the investment Ricketts would like to use the NPV of the project in order to merit the investment; Ricketts needs to know the risk of the project.

The assumptions for our calculations can be found in Appendix 1 of this paper but the major one was deciding to compare Ameritrade to Charles Schwab as they are similar firms for reasons detailed later in the paper. We used the CAPM to find the costs and then the WACC to find the cost of capital.

We found a WACC (risk of the project) of 17.61% - higher than the discount rate often used by the CFO of Ameritrade.

Ricketts should use 17.61% to discount the future cash flows from his investments.

Introduction Ameritrade is one of the first deep discount brokerage firms, founded in 1971. The firm makes the majority of its profits from the interest it charges customers for trades and not from commission fees charged for services. In 1997, the CEO of Ameritrade, Joe Ricketts, wanted to improve the company’s position; this required Ameritrade to grow its customer base. Ricketts planned on achieving this growth by investing in technological advancements (US$ 100m) and increasing the company’s advertising budget (US$ 155m). In order to decide whether the investment is worthwhile for Ameritrade, Ricketts needed to estimate the risk/reward of the project. In our paper we will estimate the cost of capital; or in other words, the risk that Ameritrade will take by comparing it to similar companies. All our assumptions will be stated during the paper and in the appendixes. Whenever making an investment in a project a factor of consideration is the NPV of the project. In order to calculate the...