MBA 676: Cost of Capital at Ameritrade - Case Study Solution

Calculation of Cost of Equity:

EW NYSE is taken as the market index for calculations. (Equal Weighted)
Return of EW NYSE: 13%.
Rf is Return of 10 year bonds: 6.34% (Assumed - Company expects to get its ROI in 10 years)

Calculation of Beta:
Beta- Ameritrade: 1.85 Beta- Charles: 0.027, Beta –Quick: 0.001 Beta- water houses: 0.05, Beta-
Etrade: 2.522.
These have been calculated after adjusting for stock splits for each of the companies. To calculate
the net beta the solutions considers the average of beta of and all the internet companies and
Ameritrade which comes to be: 2.0.

CAPM Model
Beta = 2.0
rE = Rf + β(M – Rf) = 19.66%

Maximum Beta: Beta – Yahoo : 3.71

Re in this case: 27.4%

Company should go for raising money if its excepted rate of return is more than 27.4%

Gordon Model
It is assumed that growth rate in dividends would match the growth rate in PBT and dividend at on
3/31/1997 is 1. G= 40.6% using CAGR formulae .Po = 15.62. rE = D0 (1+g)/P0+g = 49.5%

G of 40.2% is very high hence unreasonable. Looking at the dividend payout of other companies g
value varies and is not consistent across the time period.

G for water house investors = 9%

Assuming the same, Re = 15.9%

It can be safely said that Re (Cost of Capital )would be around 15.9% to 19.66%