Ameritrade: Case Study

Executive Summary As a Deep-Discount Brokerage firm, Ameritrade Holding Corporation (AHC) plans to invest in advertising and technology in order to increase their consumer base and thus revenues. The purpose of this report is to assess the riskiness of the proposed investments by considering the project’s cost of capital calculated via the Capital Asset Pricing Model (CAPM). A range of factors will be considered in order to assess each possible variable that may influence the result. Areas of focus include the risk free rate, market index average returns, the market risk premium, identifying suitable comparables and calculating the asset betas. The appropriate risk free rate was calculated using U.S. 10-year securities with an annualized YTM of 6.34%. The proposed investment is assumed to have a ten-year life cycle due to the ever-changing environments of both the discount and Internet industries and the size of investment. Market risk premiums varied depending on the chosen market index. This report opted for the VWI NYSE, AMEX and NASDAQ monthly returns due to their relevance to AHC and its risk characteristics. A historical approach was adopted using returns of the average market proxy from 84’-97’. The average annual return (15.71%) was calculated using the assumed risk free rate and VW market return, the market risk premium was assumed to be 9.37%. Asset betas were calculated using linear regression models plotting monthly market returns against individual assets returns. AHC has a short trading period (IPO in 1997), thus, available data does not satisfy requirements. To calculate beta, comparables calculated average betas for both discount brokerages and Internet industries, resulting in a project beta of 2.045. Using CAPM and the above inputs, the cost of capital was calculated to be 25.5%. This Figure reflects the risks associated with the discount brokerage industry due to low margins and revenues dependent on market performance. It is recommended AHC only