Ameritrade: Cost of Capital What factors should Ameritrade Management consider when evaluating the proposed advertising program and technology upgrades? Why?
When considering the proposed advertising program and technology upgrades, we have to ensure that the project will likely add value to the company, so we need to consider the return on investment versus the cost of capital. If the return on investment, measured by the net present value and internal rate of return, exceeds the cost of capital, the investment should be taken.
In addition, we need to evaluate the project’s systematic risk (beta), which includes risks that are not unique to a particular project and not easily manageable by a project team at a given point in time.
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From Exhibit 1, 90 % of the total net revenue of Ameritrade is from brokerage activities. Taking the brokerage revenue percentage into consideration, Charles Schwab, E*TRADE, Quick& Reilly and Waterhouse investor these deep discount brokerage firms could be used as comparable firms. Charles Schwab E*Trade Quick & Reilly Group Waterhouse Investor
Brokerage Rev (%) 82% 95% 81% 99%
*However, since E*trade historical data is so short and it is unclear if it should be valued as a technological or brokerage company, we decided to not include them in our calculations.
Using the stock price and returns data in Exhibits 4 and 5 (or, if you wish, other equivalent data sources), and the capital structure information in Exhibit 3, calculate the asset betas for the comparable firms. What is the appropriate estimation period to compile the data?
We used the following formula to derive the return of our comparable firms:
By using the company return and the Value Weighted Returns of the Market, we derived the companies’ levered equity betas and then unlevered them. β_(U Charles Schwab)=1.28246 β_(U Quick&Reilly)=2.3388 β_(U Waterhouse Investors)=0.4221
Since we did not have any data to establish appropriate weights, we used the arithmetic mean to derive a beta for Ameritrade.
Average
2. Beta for mercury is calculated by comparison with the companies having similar debt/equity ratio (25%). This beta is used in the calculation of cost of equity afterwards. The equity beta comes out to be 1.12.
risks and determine the likelihood and consequence of that risk occurring during the project. The
We are interested in obtaining the asset beta for Collinsville investment. Here from the reading material, we find there were altogether 6 chemical companies that produce sodium chlorates. They are Hooker, Pennwalt, American, Kerr-McGee, Brunswick and Southern. However, since we are evaluating the addition of a sodium chlorate plant, the two firms (Brunswick and Southern) who specialize in producing sodium chlorate are likely the best “twins”. To determine the asset betas of each company, we
The table below shows the equity betas for the firms presented in the case (using Jan-92 to Dec-96 equal weight NYSE/AMEX/NASDAQ as market portfolio):
b) The decision to invest in projects increases the shareholders value of the company. This is consistent with the growth and from the NPV criteria, positive NPV of projects increases the shareholder's value.
Here we choose VW NYSE, AMEX, and NASDAQ data as market returns, because it’s value weighted and more reliable. The results show CSC’s equity beta = 2.27, QRG’s equity beta = 1.79.
A correct response requires that you find an appropriate industry beta and measure for levered/unlevered betas and requires that you define cost of equity capital and free cash flow (FCF) – you may need a formula for FCF.
The historical beta comes from historical data. This kind of beta would slope coefficient in a regression, and associated with company's stock returns and market returns. This approach is conceptually straightforward, and complications quickly arise in practice.
* Stock Beta: Exhibit 5 shows a detailed measurement of the company’s stock returns in relation to the rest of the market through 5-year historical price and index data. The analysis includes monthly returns of both the NYSE and the S&P 500 index in order to capture a comprehensive view of the market return. In each comparison, the monthly returns of the Target stock and market are plotted on Y-axis and X-axis respectively to get the regression line’s slope or beta. The analysis arrives at an average beta of 0.988 which indicates a similar movement of Target stock’s returns in comparison to the whole market over time.
It is used as a means of input to the risk management plan processes (Heldman, 2005). It usually helps the project managers and the project team to recognize the components of a project that are at risk or certain risks that are unique to a specific area of the project than compared to a risk that is commonly found throughout the project. There also various qualitative analysis that can be used to in identifying and analyzing risk in a project. The method of qualitative risk analysis involves the assignment of a numeric value to the scales. This risk analysis is normally used for projects that are larger and that risks have a greater and more significant impact (Heldman, 2005). There are various software tools and methods that can be used, an example would be the use of Monte Carlo analysis for calculating values for projects that are large and difficult. There are various values that are assigned to the magnitude or intensity of the risk, for example, High-.80, Medimum-.50, Low-.10; these are used to rate and prioritize the risks (Heldman, 2005). A risk registry is also an essential documentation that can be used analyze the quantitative aspect related to risk and threats that are found throughout the project. The Risk Breakdown Structure is created to identify the various risks categories in the project so that they can be in the prioritized response plan (Heldman,
The regression that we performed in excel for both stocks yielded a beta of .73576 for Reynolds, and a beta of 1.4198 for Hasbro. In question 2 we learned that although Reynolds stock was riskier independently, adding it to the portfolio made it more diversified compared to adding Hasbro, due to the fact that it was less correlated to the market portfolio. Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Therefore, since the beta of Reynolds is lower than Hasbro, our beta calculations align with the fact that Reynolds stock makes the overall portfolio less risky. This finding is also intuitive when considering the nature of the companies; Reynolds is a Tobacco company meaning that is should be less sensitive to changes in market conditions than a toy company like Hasbro.
The Equity beta for the whole company and for the commercial division is calculated in the appendix.
1.a) To value Spyder Active Sports Inc., we decided to use the WACC method since we can easily value its cost of assets with the data immediately available to us in the case. We first unlevered the beta’s of 7 comparable companies and took the average to get a comparable unlevered beta for Spyder (Exhibit 1). Since we are assuming Spyder is entirely equity financed, its unlevered asset beta is equal to the beta of its assets. We now have a rough estimate of Spyder’s asset beta, we can
This indicates a risk for a potential investor, as there is not enough substantiating information detailing the previous fiscal years’ performances and whether there is a trend of net income or net loss percentage from year to year (Harrison, Horngren, Lemon, & Seguin, 2014, pg. 24).
Pine Street Capital’s Portfolio on July 26th,2000 Ticker shares share price total Allocation Beta Alpha R-Squared