DUKE UNIVERSITY

Fuqua School of Business

FINANCE 251F/351
Individual Assignment #1
Cost of Capital at Ameritrade
Prof. Simon Gervais

Spring 2010 Term 1

In this case, you have to use data from comparables to estimate the cost of capital at Ameritrade.
The process involves a few stages that this handout will guide you through. First, we need to
determine which set of firms to use as comparable firms. You should try two different sets. The
first set will include three discount brokerage firms: Charles Schwab Corp, Quick & Reilly Group,
and Waterhouse Investor Services.1 The second set will include six investment services firms:
A G Edwards, Bear Sterns, Merrill Lynch, Morgan Stanley Dean Witter, Paine Webber, and
Raymond James Financial. Stock price and return data for these nine firms are provided in a
separate spreadsheet that you can download from the course schedule at www.duke.edu/sgervais.
In fact, this spreadsheet contains all six exhibits contained in the case.
To estimate the equity beta for each of these firms, you will need to perform a regression of their
past returns on past market returns (only the slope of this regression is useful for your analysis,
i.e., there is no need to calculate/report on anything else). For this purpose, let us use monthly
data from January 1992 through December 1996, that is, five years of monthly data as is the norm
in practice.2 As you will see in Exhibit 5, the data for the discount brokerage firms includes stock
price, dividend and stock split data. You will have to calculate monthly returns using this data. To
help with the calculation of monthly returns, note that the return Rt of a stock in a given month t
is

Pt Pt1 +Dt
if there is no stock split
Pt1
Rt =
x
x

y Pt Pt1 + y Dt if there is an x for y stock split,

Pt1

where Pt denotes the stock price at the end of month t, and Dt denotes the dividend paid in
month t. Exhibit 6 reports the monthly returns on the six investment services firms stocks, which
you can use directly. The same exhibit also reports monthly returns on the value-weighted index
of all U.S. publicly traded firms (on the NYSE, AMEX, and Nasdaq), which you should use as the
market portfolio in your analysis.
Once you have estimated the equity beta for all nine comparable firms, calculate the asset beta
for each firm. In your calculations, assume that the corporate tax rate is zero, an assumption that
we will revisit later in the course. Given that your regressions use data from 1992 through 1996,
use the Avg 1992-1996 debt-to-value ratios reported in Exhibit 4 for your calculations (use the
market values ratios, of course). Finally, your will need a debt beta for all nine firms. Since debt
betas are not provided in the case, assume initially that the debt beta is zero for all nine firms.
Then redo your analysis using a debt beta of 0.25 for all nine firms.
The last step of the process involves the estimation of Ameritrades cost of capital, i.e., the
hurdle rate that it should use for its projects. From the case, it looks like Ameritrade uses little or
1

E*Trade has recently gone public and there is not enough data available to use it as a comparable at this point.
As you will see, the data for Waterhouse Investor Services ends in September 1996. For this one firm, use only
the 57 data points from 1992-96, as this should be enough.
2

no debt for financing its projects. Let us assume that it will keep financing its operations without
using debt, i.e., let us assume that it will remain all-equity financed for the foreseeable future. Use
your two sets of comparables (discount brokerage firms and investment services firms) and your
two assumptions about their debt beta (0.00 and 0.25) to produce four estimates of Ameritrades
cost of capital. Within each set of firms, you can weigh the firms equally (i.e., 1/3 each for the first
set, and 1/6 each for the second set). Also, for your cost of capital calculations, use the CAPM
with the following assumptions.
The riskfree rate, rf , is 6.61%. That is, let us use the yield on long-term U.S. Government
bonds.
The risk premium on the market portfolio, rm rf , is 7.20%. We will discuss how to estimate
this number later in the course.
The first page of your report should be an executive summary similar to that on the last page
of this handout. In fact, such a page is included in the spreadsheet that contains the data; feel free
to use it. On the second page of your report, you should provide brief answers to the following
three questions.
Why is the asset beta of discount brokerage firms larger than the beta of investment services
firms?
Which set of comparable firms (discount brokerage or investment services) is more appropriate
for Ameritrade to use and why?
For the market portfolio, why is it more appropriate to use the value-weighted index of all
U.S. publicly traded firms as opposed to the equal-weighted index?
Finally, the rest of your report should include more details about your work (i.e., your spreadsheets),
including your monthly return calculations for the three discount brokerage firms. Please make sure
that this is presented in legible fashion so that your report can be graded efficiently and accurately.

FINANCE 251F/351
Spring 2010 - Term 1
Individual Assignment #1
Last name: Gervais
First name: Simon
Section: 30A or 30B (for Fin251F), 301, 302 or 303 (for Fin351)

Cost of Capital at Ameritrade: Executive Summary

Market Data
r m - rf =
7.20%
rf =
6.61%

Firm
Charles Schwab
Quick & Reilly
Waterhouse

Discount Brokerage Firms

Debt / Value Equity Beta
(Market Value)
0.00
0.00
0.00

0.00
0.00
0.00

Equal-Weight Average

Firm
A G Edwards
Bear Sterns
Merrill Lynch
Morgan Stanley Dean Witter
Paine Webber
Raymond James Financial

Investment Services Firms

Debt / Value Equity Beta
(Market Value)
0.00
0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00
0.00

Equal-Weight Average

Asset Beta
(D=0.0)

Asset Beta
(D=0.25)

0.00
0.00
0.00

0.00
0.00
0.00

0.00

0.00

Asset Beta
(D=0.0)

Asset Beta
(D=0.25)

0.00
0.00
0.00
0.00
0.00
0.00

0.00
0.00
0.00
0.00
0.00
0.00

0.00

0.00

Assuming
D=0.0

Assuming
D=0.25

0.0%
0.0%

0.0%
0.0%

Cost of Capital Estimates

Based on
Discount Brokerage Firms
Investment Services Firms