1366455889_61440c8dc3dbddc58ed192f3b5802b4c

1366455889_61440c8dc3dbddc58ed192f3b5802b4c - Case Study...

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Case Study Guidelines Students are required to read closely the assessment criteria for both case study presentation and written report as listed on the course outline (page 7 to 9). Case Study Questions Cost of Capital at Ameritrade 1) What factors should Ameritrade management consider when evaluating the proposed advertising program and technology upgrades? Why? 2) How can the Capital Asset Pricing Model be used to estimate the cost of capital for a real (not financial) investment decision? 3) What is the estimate of the risk-free rate and market risk premium that should be employed in calculating the cost of capital for Ameritrade? 4) In principle, what are the steps for computing the asset beta in the CAPM for purposes of calculating the cost of capital for a project? 5) Ameritrade does not have a beta estimate as the firm has been publicly traded for only a short time period. Exhibit 4 provides various choices of comparable firms. What comparable firms do you recommend as the appropriate benchmarks for evaluating the risk of Ameritrade’s planned advertising and technology investments? 6) Using the stock price and returns data in Exhibit 4 and 5, and the capital structure information in Exhibit 3, calculate the asset betas for the comparable firms. 7) How should Joe Ricketts, the CEO of Ameritrade, view the cost of capital estimate you have calculated?
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What factors Ameritrade should consider when evaluating the proposed advertising program and technology upgrades? Sustainability of the project- how long can Ameritrade maintain a cost leadership strategy before the project becomes obsolete. This will assist in estimating the expected future cash flows necessary for evaluating the project. V= CF/(1+WACC) t The risk free rate Market risk premium Beta Cost of debt- the cost of raising debt have an impact on the WACC equation Financing mix- how you are going to fund the project. The financing mix should minimise the hurdle rate and match the asset being financed. The proportion raised by debt and equity must maintain their target capital structure or debt to equity ratio. This will affect the WACC equation. State of the economy once the project is implemented. Ameritrade’s revenue is tied to the stock market. Decision tree analysis can be used to determine the possible outcomes or value of the project given the probability of different economic scenarios- high, average and low demand. The risk of the project- the hurdle rate should be higher for riskier project than for safer projects. The hurdle rate- invests in projects that yield a return greater than the minimum acceptable hurdle rate. Since financial resources are finite, there is a hurdle that projects have to cross be being deemed acceptable. In this case, the hurdle rate is the WACC of the project.
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