Cost Of Capital At Ameritrade
SubCost of Capital at Ameritrade
Ameritrade Holding Corporation (AMTD) is a deep-discount brokerage firm that has recently completed an IPO. Management at Ameritrade is considering substantial investments in technology and advertising to exploit emerging economies of scale, but is unsure of the appropriate cost of capital.
We can use capital market data and the Capital Asset Pricing Model (CAPM) to estimate the required rate of return for real investments.
Ameritrade?s potential investments are expected to yield cash flows over the next several years. To determine the present value of these cash flows and thus determine the attractiveness of potential investments, a cost of capital is required.
A firm maximizes its value by taking all positive NPV projects.
The CAPM provides a framework for determining the discount rate.
Estimating the risk-free rate
General guidelines. Reasonable people (financial analysts) can disagree.
Match to the economic life of the project
This is a long-term project
Current versus historical rates
Use prevailing rate
Exhibit 3 of the case: the current yield on long-term US government bonds is 6.61%
Estimating the market risk premium
Recall that the market risk premium measures the expected return of the market in excess of the risk-free rate required to compensate investors for risk of uncertain future cash flows.
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