Ameritrade Case Study Solution

1.

Ameritrade's primary revenue sources are from transaction and interest, both of which are directly linked to the stock market. Ameritrade's investment project had the goal of offering low-cost automated service to self-directed investors, so the return on the project must be linked to the stock market as well. Therefore, we think that it makes sense to compare Ameritrade with deep-discount brokerage companies who have the same kind of sensitivity to the stock market. These companies are Charles-Schwab, E-trade, Quick & Reilly, and Waterhouse Investor Services.

2.

First, we calculated the monthly return data for Charles-Schwab, E-trade, Quick & Reilly, and Waterhouse Investor Services, adjusted for stock splits and dividends.

We then matched the monthly return data to the value-weighted monthly market return data to the stock's monthly returns.

With stock returns and market returns, we calculated the beta of each stock:

Charles-Schwab: 2.318

E-trade: 2.772

Quick & Reilly: 2.167

Waterhouse Investor Services: 1.390

Assuming that debt return is not correlated with the stock market, then the asset beta of each firm is simply stock beta * equity weight (we used the 1992-1996 average market value data if available):

Charles-Schwab: 2.318*0.92 = 2.133

E-trade: 2.772*1 = 2.772

Quick & Reilly: 2.167*1 = 2.167

Waterhouse Investor Services: 1.390*0.62 = 0.862

From Ameritrade's income statement, we know that its brokerage income makes up about 90% of its total revenue. E-trade has the closest number - 95%. So we think that E-trade's Beta should be used.

3.

Risk free rate = 6.61%

Beta = 2.772

We use average annual return of large company stocks (1950 - 1996) as our expected market return: 14.0%

Therefore expected project return = 6.61% + 2.772*( 14.0% - 6.61%) = 27.10%

We think that the 30-year bond yield is not appropriate, as the project will last much shorter than 30 years.