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COST OF CAPITAL AT AMERITRADE

By:
Group 17
Ankita Susan Tigga – 0067/52
Ankur – 0068/52
Ankur Jain – 0069/52
Ashish Meena – 0070/52

1.

What are appropriate proxy companies and the reasons for this?

2. approximately 90% brokerage revenue for Ameritrade and 82%. RF has been taken to be 5. We also note that the revenue structure of Ameritrade is somewhat similar to these 3 firms (i.e.56. we assume Debt of Ameritrade to be zero as Ameritrade has no interest bearing debt. The Levered beta then becomes equal to the unlevered Beta.21. Hence these 3 firms seem to be the suitable choices as proxy companies. we take the historical average annual return for large company stocks as 12.e.61% (Yield on US Government Securities for 30 years). Estimation of Ameritrade’s cost of capital . Therefore the market risk premium is given as 12. unlike other brokerage firms which are involved in stocks. We then use historical risk free rate to calculate risk premium in the market. Quick & Reilly Group and Waterhouse investor services.7% .21.5. The slope then provides the value of levered Beta (average of all 3 firms) as 2. 99% for Charles Schwab. involved in Discount brokerage) with sufficient stock price and return data (available for the past 5 years) are Charles Schwab.5% = 7. To lever the Beta again. From exhibit 3. we see that the 3 firms similar to Ameritrade (i. Upon going through the Exhibit 4. 81%. The risk free market rate has been taken from the exhibit 3 as 6. we have taken the previous 5 years’ data for the 3 proxy companies. Upon un-levering the Betas (using market value of Debt/Equity) for the 3 firms. 2.Ameritrade being a discount brokerage firm supplies services related to the trade.7%. The two primary sources of revenue for Ameritrade were from transaction and net interest. We chose this to be the Market risk fluctuation of large companies will primarily determine the fluctuations in the market. i.5% which is the average annual return for long term bonds as this represents return of bonds with highest maturity (20 years). Estimation of betas For estimation of Betas. Quick & Reilly Group and Waterhouse investor services respectively). [Calculation of the aforementioned has been presented in the Excel Sheet attached] 3.e. we obtain the unlevered Beta as 2.2% The process of estimation of Beta involves running a regression Return on the all 3 company’s stocks and the market return during the corresponding time period.

Also return on stock from exhibit 5 is present for all 3 proxy companies is present in exhibit 5. we employ the CAPM. What is the justification for using the approach you have used? The logic for some of the assumptions that we have made include:     We have not used E* trade as one of proxy firms even though it too is a Discount brokerage firm with revenue structure similar to Ameritrade.2% Hence RE = 22. RE = 6.53% 4. We have taken the data for past 5 years since the debt to total capital ratios in Exhibit 4 are for the period 1992-1996. We have. this assumption seems reasonable.53% Since we have assumed the debt to be equal to zero. our R E represents the overall Cost of Capital for Ameritrade. . both being probable outcomes. Hence taking the largest period possible to maximize data points seems to be the best choice.21 * 7.61% + 2. We have taken the long term debt for Ameritrade as zero as seen from the balance sheet. (Since in WACC. The other 3 proxy companies are assumed to accurately represent the market Beta. RE = RF + β (RM – RF ) Therefore. The argument for taking Historic average returns from 1929 – 1996 is that there is a lot of uncertainty in the future as well with economic recession or economic boom. since even the Income sheet does not indicate any Interest expenses.To estimate the Ameritrade’s cost of capital. Also. This is because we do not have enough data to estimate Beta for E* trade. RD = 0) WACC = 22.