Ameritrade Case Write-Up Essay Example

a leader in deep-discount brokerage. Other firms in similar business with are Charles Schwab, E*Trade, Quick & Reilly and Waterhouse Investors.

Charles Schwab, E*Trade and Quick & Reilly have very low debt to value ratio and majority of their revenue is coming from brokerage. Also Charles Schwab and E*Trade have similar online brokerage business as Ameritrade. Thus these three firms are good candidates for determining Ameritrade’s beta. 4. Using the stock price and return data in Exhibits 5 and 6, estimate the CAPM beta. Using the stock price and return data the mean return, sigma and beta was calculated for all the firms in Exhibits 5 and 6. While calculating these numbers I used data from Jan 92 to Dec 96.

From the table we see that beta equity for Charles Schwab, E*Trade and Quick & Reilly is 2. 26, 2. 83 and 2. 17 respectively. We know beta asset = beta equity * equity/value + beta debt * debt/value Thus beta asset of Charles Schwab = 2. 26*0. 92 + 0*0. 08 = 2. 08 Thus beta asset of E*Trade = 2. 83*1. 00 + 0*0. 00 = 2. 83 Thus beta asset of Quick & Reilly = 2. 17*1. 00 + 0*0. 00 = 2. 17 I decided to use Charles Schwab as beta twin because it has data for last five years and has online brokerage business. 5. Estimate the cost of capital for Ameritrade’s proposed project. Assume the risk free rate is 6. 4% and the market risk premium, (rm-rf), is 7. 6%. Cost of capital for Ameritrade’s proposed project = rf + beta asset of twin * (rm – rf) WACC =

6. 34% + 2. 08 * 7. 6% = 22. 15% The cost of capital for the project is high. The estimated cost of capital represents the risk of real investments in the discount brokerage industry. The discount brokerage business has very high systematic risk. All of the revenues are linked to stock market activity and performance. If Ameritrade uses debt to finance the project, the cost of capital may fall but the equity beta (and the cost of equity) will increase with the level of leverage used.