Ameritrade Case Study
Project Description
In order to execute on Ameritrade’s strategy to grow its customer base, Chairman and CEO Joe Ricketts is considering a substantial project that would (1) implement technology enhancements to improve the trading platform and (2) increase advertising to grow consumer awareness. The technology enhancements require a $100 million investment and the advertising budget would be increased to $155 million for combined FY 1998 and 1999, more than seven times the Advertising and Promotion expense of $21 million in FY 1996 and 1997, as shown in Exhibit 1 of the case.
What is Cost of Capital
Cost of capital for a project is the return that the company, in this case Ameritrade, would be able to achieve in the market if it had invested in a security with the same risk as the project. Cost of capital is important because to analyze whether a project is profitable, one must discount the future cash flows of the project at the cost of capital, and compare these to the original investment. Most generally, a project’s cost of capital depends on the time value of money, and on the riskiness of the project. Specifically, assuming that the project is completely financed with equity, using CAPM, the other factors that affect cost of capital are the risk free rate on a treasury security with a similar duration as the project, the sensitivity of the project returns to market movements, and the market’s appetite for risk.
Comparable Companies
Exhibit 4 lists various choices for possible comparable firms, including firms in the Discount Brokerage, Internet, and Investment Services industries. In choosing the comparable firms, we first decided to exclude firms in the Investment Services industry. Firms such as Bear Stearns and Lehman Brothers, while providing brokerage services, also derive a significant portion of revenues