Ameritrade Case Analysis

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AMERITRADE COST OF CAPITAL ANALYSIS Questions: 1. What factors should Ameritrade management consider when evaluating the proposed advertising program and technology upgrades? Why? Ameritrade management should consider the opportunity cost of capital for the proposed advertising program and technology upgrades. It is important that Ameritrade not emphasize it’s company cost of capital, which is the opportunity cost of capital for investment in all the firm’s assets, and therefore becomes problematic if the firm is looking at a new project/asset (because most likely this new project will be more/less risky than the firm’s exist business). In addition, Ameritrade needs to identify with a certain type of business. Are they a discount brokerage or an internet/technology firm? There are varying levels of risk associated with new projects in both these areas. Essentially, Ameritrade needs a cost of capital to evaluate new projects. Firms maximize their value by taking all positive NPV projects. To calculate the NPV, we need a discount rate. According to the case briefing, the CFO of the firm often used 15% as the internal discount rate, but some managers felt the borrowing cost of 8-9% was the appropriate rate by which to discount future profit estimates. At this time, the external discount rate, used by Credit Swiss First Boston was 12%. What does this mean? If Ameritrade analysts use a discount rate that is too high, good projects may be rejected. If they use a discount rate that is too low, bad projects may be accepted. Lastly, they need to make sure that the future cash inflows due to this project outweigh its future cash outflows. Ameritrade's managers should also consider what taking on these programs would do to its capital structure. They might have a certain debt to equity ratio they wish to maintain, or perhaps there would be covenants put on
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