Cost of Capital at Ameritrade

Cost of Capital at Ameritrade

In mid-1997, Joe Ricketts, Chairman and CEO of Ameritrade Holding Corporation, wanted to improve his company’s competitive position in deep-discount brokerage1 by taking advantage of emerging economies of scale. The success of the strategy required Ameritrade grow its customer base. The growth would require substantial investments in technology to improve service and capacity, and in advertising, to increase customer awareness. The strategy would require large expenditures relative to Ameritrade’s existing capital. In order to evaluate whether the strategy would generate sufficient future cash flows to merit the investment, Ricketts needed an estimate of the project’s risk.
Company Background
Formed in 1971, Ameritrade has been a pioneer in the deep-discount brokerage sector. Not only did Ameritrade help create the deep discount market, but it also was the first to offer many new services that changed the way individual investors managed their portfolios. Ameritrade, for example, was the first to offer automated touch-tone phone trading (1988), online internet trading2 (1994), a personal digital assistant to access trades (1995), and online program investing for individual investors (1996).
The average return on equity during 1975 to 1996 was 40%, as all years, except two, posted a positive return. Recent returns on equity were much higher, with each of the most recent five years having larger returns than the 40% average.
In March 1997, Ameritrade (NASDAQ: AMTD) raised $22.5 million in an initial public offering allowing the company to continue its long tradition of adopting the latest advances in technology, and to substantially increase advertising to build its brand and improve market share.Revenue Sources
Exhibit 1 displays Ameritrade’s income statement for the fiscal years 1995-1997 and Exhibit 2 presents the balance sheet for 1996 and 1997.
Ameritrade’s two primary sources of revenue were from transaction and net interest. Transaction revenues...

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