Ameritrade Case

Essay Preview: Ameritrade Case

Report this essay

Executive SummaryIn 1997 Joe Ricketts, CEO of TD Ameritrade, wanted to analyze an investment opportunity that would substantially grow the company. The Investment would be used for technological advancements and advertising and would hopefully lead to an increase in its customer base that would last for years to come. He hired our team to help identify the risk through the cost of capital calculation. We have decided to use a US Government 30 Year Bond rate of 6.61%. This is because the project and the customers are considered to be long term. The Market Risk Premium for the project is based on the difference of the Market Return and Risk Free Return. Ameritrade has a Market capitalization of approximately $259 Million. This indicates to us that it is a small cap company. We will thus use Small Comparable stocks from 1950 â€“ 1996 as the basis for the Market Return for this evaluation. Thus, the Market Risk Premium is 17.6% – 6.61% = 11.19%.To calculate the Beta of the project, we follow the following steps: Locate suitable comparable companies, Determine the equity betas of the proxy companies, their gearings and tax rates, Unlever the equity betas to obtain asset betas, Calculate the average asset beta, and finally, Use the CAPM to calculate a project-specific cost of equity.In the case of Ameritrade, we have used the following companies as comparables: Bear Stearns, Merrill Lynch & Co, Paine Webber, and Raymond James Financial. These firms have been chosen over other firms since they show a better representation of the industry/project Ameritrade is focusing on as well as a more comparable revenue source in terms of the percent of their total revenue that is based on Brokerage Fees. Some other firms have not been chosen because they operate with no debt while Ameritrade has about 90% Debt to Value. Lastly, some of the companies are looked over because they operate in a different industry such as Yahoo! and Netscape that are both internet companies and not brokerage firms of any sort.After doing a regression analysis of the four comparable firms to the Value Weighted Market Index, we are able to figure out the Equity Beta for each company. As we solve back for each firm, we are able to get the Asset Beta for each firm. Averaging this out, gives us the average comparable Asset Beta we can use for Ameritrade of 11.88.When calculating the cost of capital, we will first need to calculate the cost of equity. In doing this we will use the risk-free rate, equity beta, and the market risk premium to get a cost of equity of 139.1%. Then we will calculate the cost of debt using the risk-free rate and the debt beta equal to 6.61%. We will then calculate the weighted average cost of capital (WACC). When calculating the WACC we will use the equity / total value, firmâ€™s cost of equity, debt / total value, the cost of debt, and the tax adjusted interest expense. The WACC comes up to 11.13Joe Rickets the CEO will be disappointed to see that the cost of capital is 11.13%. Although this is better than the 15% discount rate mentioned by the CFO at Ameritrade, Joe should have been hopeful that it would be in line with some of the managers at Ameritrade estimates that cost of borrowing should be 8-9%. With that said, we do believe that he will go ahead with the project to bring long-term growth to TD Ameritrade.TD Ameritrade is using this investment for technological enhancements and advertising. Advertising will increase its customer base significantly. These customers are expected to be long term customers so this project should be considered long-term. When finding the risk-free rate for a long-term project you want to take the longest-term government bond. In this case we will refer to Exhibit 3 and use the U.S. Government 30-year Bond yielding 6.61%.To calculate the market risk premium, we will use the risk-free rate and subtract it from an average of comparable stock market returns. When deciding what stocks to use as comparables first we will want to look at TD Ameritradeâ€™s market capitalization rate. With TD Ameritradeâ€™s market cap at $269 million, we consider it a small cap company (Figure 1). We also want comparable returns that are from a long historical average. We have 2 options for small-cap comparable in Exhibit 3. One is from 1929-1996 and the other is from 1950-1996. Although generally the longer the better when looking at historical averages we will argue there could be extreme outliers from the stock market crash in 1929. Because the 1929 crash, we will use the small comparable stocks from 1950-1996, which is 17.8%. After subtracting 6.61% from 17.8% we get market risk premium of 11.19% (Figure 2). It is possible that we could use large cap or other comparable companies if we could make the argument that the comps were companies that were more like TD Ameritrade from a business perspective. We could have used the comparable discount brokerâ€™s given in Exhibit 5 but we donâ€™t know how big the companies are or what their exact business models are. For this reason, we felt like we should stick with the small company comparables from 1950-1996.Figure 1Shares outstanding 13,768,889Stock market price $ 18.81Market Cap$ 258,992,802Â Â Â Â Â Â Â Â Figure 2Small comparable stock returns (1950-1996)17.8%Risk-free rate (30-year U.S. government bond)6.61%Market risk premium11.19%Beta is calculated through the following steps:Locate suitable comparable companiesDetermine the equity betas of the proxy companies, their gearings and tax ratesUnlever the equity betas to obtain asset betasCalculate the average asset betaUse the CAPM to calculate a project-specific cost of equityComparable firms to use as benchmarks for evaluating the risk of Ameritradeâ€™s planned advertising and technology investments includes the following: Bear Stearns, Merrill Lynch & Co, Paine Webber, and Raymond James Financial. These firms have been chosen over other firms since they show a better representation of the industry/project Ameritrade is focusing on as well as a more comparable revenue source in terms of the percent of their total revenue that is based on Brokerage Fees. Some other firms have not been chosen because they operate with no debt while Ameritrade has about 90% debt to Value. Lastly, some of the companies are looked over because they operate in a different industry such as Yahoo! and Netscape that are both internet companies and not brokerage firms of any sort.Using Regression and Stock returns from Exhibit 6, we can figure out the Equity Betaâ€™s for the comparable companies we talked about earlier and the Value Weighted Stock Market Index. Equity Beta for Bear Stearns = 1.7478Equity Beta for Merrill Lynch = 1.8956Equity Beta for Paine Webber = 1.9281Equity Beta for Raymond James = 1.3701More detailed regression analysis can be found in the Exhibit.Using these Equity Betaâ€™s, we can figure out the Asset Betaâ€™s for the four comparable firms. We can thus get the average and use that as the basis for the Asset Beta for Ameritrade. And finally recalculating back using the Beta formula, we can figure out the Asset Beta for Ameritrade. Ameritrade has an Equity Beta of 11.88 which although is very high, is due to the High Debt/Value ratio that they currently have as well as our assumption that Debt Beta and Tax Rate are 0%. If these were changed to the current market values, we could have a lower Equity Beta.

# Essay About Beta Of The Project And Equity Betas Of The Proxy Companies

Essay, Pages 1 (1222 words)

Latest Update: April 3, 2021

Views: 98

*Related Topics:*