139548943-AmeriTrade-Case-Study

139548943-AmeriTrade-Case-Study - Case 6 Cost of Capital at...

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Case 6: Cost of Capital at Ameritrade Summary: Formed in 1971, Ameritrade Holding Corporation has been a pioneer in the deep- discount brokerage sector, with its main sources of revenue being from transaction and net interest. Virtually all of Ameritrade’s revenues were directly linked to the stock market, so the state of it has a great effect on the company’s brokerage commissions and net interest revenues. Full-service brokers were less sensitive to market movements than Ameritrade given that they received asset management fees, which partially shielded the revenue stream from market declines. Also, they engaged in investment banking activities such as mergers and security underwritings to diversify their revenue. In mid-1997, Joe Ricketts, Chairman and CEO, wanted to improve the competitive position of the company in this sector by taking advantage of emerging economies of scale. To do so, he wanted to implement a strategy that focuses on growing Ameritrade’s customer base by cutting prices, enhancing the technology, and increasing advertising. First, Ameritrade would have to reduce commissions from $29.95 to $8.00 per trade for all Internet market orders given that there were currently no major players in this price range although many customers were price sensitive. Also, Ricketts believed that state of the art technology was the sole way of preventing system outages and to move toward the goal of 100% reliability. Therefore, up to $100M would be budgeted for technology enhancements which also would increase trade execution speed - an important feature to individual investors. Finally, Ameritrade’s advertising budget would be increased by $155M for the 1998 and 1999 fiscal years combined. To gauge the financial impact of the advertising program and the investment in physical plant and technology required to carry out the strategy, there needed to be some accounting for the project’s risk. Of course, the plan would only create value if the investment returned more than it cost. Because Ricketts believed that his role as CEO
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