Ameritrade Case

Rickets believes hat the investment specie carries a lot of happen that requiring a more in-depth fiscal acknowledgment as opposed to Marinades existing financial policy. Through initial discussions with Mr.. Rickets, we save agree upon a financial analysis, adopting the camping ground mannerl, to calculate the cost of seat of government of the investment. Mr.. Rickets & his precaution team go forth then make a sound financial decision basing on our analysis results. According to our agreed plans, Mr.. Rickets has specifically requested us to perform the following ternion tasks and provide our recommendation accordingly. . Briefly discuss the addition genus of import and CAMP shape, and explain the stairs for computing the asset strategic and CAMP to earn the cost of superior for the Investment project. II. Mr.. Rickets is aware that Marinated does not give way a beta pre attain to the woods due to short trading history, and demands us to hand pick corresponding fi rms that will be valuable In assessing the risk of Marinades planned Investment. Ill. Using the supplied financial data to calculate the asset betas for the comparable firms. L. rendering of asset beta.Beta roleplays a measure of the volatility, or self-opinionated risk, of a security or a oratorio in equivalence to the securities industryplace place as a self-coloured. It is similarly cognise as beta coefficient. And Is calculated using regression analysis. It represents the tendency of a securitys dies to respond to swings in the market. Beta can be calculated by dividing the covariance between the give in on the asset and the return on the market and the variance of the market This alliance is represented by the following formula Levered versus unleavened Beta.Unleavened Beta compares the risk of an unleavened company to the risk of the market. The unleavened beta Is the beta of a company without any debt. Enlivening a beta removes the financial effects from leverag e. The formula to calculate a companys unleavened beta is This subprogram provides a measure of how much systematic risk a firms fair play has when compared to the market. Enlivening the beta removes any beneficial effects gained by adding debt to the firms pileus structure.Comparing companies unleavened betas gives an Investor a better Idea of how much risk they will be taking on when purchasing a firms stock. Levered Beta, on the contrary, represents market risk of the investment taking into consideration market risk of the debt. Definition of CAMP (Capital Asset Pricing Model) CAMP is a model that describes the relationship between risk and expected return and that is used in the price of risky securities. The cost of equity is approximated Premium). Definition of the cost of not bad(p).The cost of funds used for financing a business. Cost of nifty depends on the mode of financing used it refers to the cost of equity if the business is financed solely with equity, or to th e cost of debt if it is financed solely through debt. Many companies use a combination of debt and equity to finance their businesses, and for much(prenominal) companies, their overall cost of capital is derived from a weighted average of all capital sources, widely known as the weighted average cost of capital (WAC).Since the cost of capital represents a hurdle rate that a company must overwhelm before it can generate value, it is extensively used in the capital budgeting process to determine whether the company should proceed with a project. Steps in calculating Beta for Marinated With the above explanation, the cost of capital for Marinated is, calculated by the CAMP model, will be using the three major tonuss 1. Determine the Ref (risk-free rate) hat better(p) reflects the market 2. Determine the Asset Beta for Marinated 3. Determine RMI (market-return rate).We will decide on the Ref and RMI with the supplied return data (Historical and current). On the early(a) hand, we wi ll diligently pick the best comparable firms, and then calculate the covariance between the past returns on the comparable firms and the return on market portfolio. Lastly, we produce a beta estimate by dividing the covariance (previously calculated) by the variance of the market. Market stock returns for indices such as NYSE, AMES and Nasdaq, which present the weighed average of all US publicly traded firms, are ready(prenominal) in Exhibit 6 of the case.The returns are presented for the time period of 1984 to 1997. Returns on comparable firms in the Investment Services industry are also presented in the same exhibit. It is important to point out that the firms presented are full- utility securities firm firms and are less sensitive to market movements than Marinated due to the fact that deep- disregard brokers such as Marinated do not engage in asset management and investment banking services equal full-service brokers do. Marinades revenue stream is fully strung-out on its br okerage operations.Given the above, we suggest to calculate covariance between each peerless of the cardinal investment services firms presented and the market as a whole represented by the indices provided. Next step is to divide each of the results from step one by the market variance calculated found on the indices presented in Exhibit 6. In essence, we stick out calculated Betas for each of the four comparable firms. Then we would calculate an average of the four betas to use as an estimated Beta for Marinated. However, as motioned above, Marinated has a more volatile business model than full service investment firms.Therefore, we need to increase the resulting Beta by some estimated factor in order to be able to represent corresponding market risk more accurately. II. In determining the entrance comparable for Marinated, we ran into a challenge of finding a direct resemblance in both operational risk and capital structure risk. In this analysis, we are making the assumpt ion that Marinated will need to take on some debt in order to fund the additional investments in to engine room and marketing squired.We decided to look at three types of companies for as potential drop comps for Br early(a)s, Merrill Lynch, etc. ) 2) Discount Brokerage Firms (e. G. Charles Schwab, E*Trade, Quick & Reilly Group, etc. ) 3) net income Companies (e. G. Macromedia, Netscape, Yahoo) Operationally the full service brokers dont share the same level of risk as Marinated. Marinades business is very sensitive to the performance of the stock market since almost all of their revenue is generated through brokerage. During a market decline, investors tend to decrease investing activities, thus Marinades venue suffers.The full service brokers devote less sensitivity to the overall market because the also offer other services, such as asset management and investment banking. The higher operating risk associated with brush aside brokerage firms, including Marinated, would lead to higher betas in equation to the full service brokers. In comparing the capital structure of the other discount brokerage firms, Marinated will have more risk (requiring a high Beta) since they will be press outing debt (other than Charles Schwab (. 25) Debt-to-Capital, none of the other discount brokerages channelize debt).We do feel that Marinades competitive advantage over the other discount brokerage firms comes through technology (more specifically reliable internet based transactions), so using other internet based companies as comps makes sense. But, like the other discount brokerage firms, the other internet comps carry no debt, so the financial risk is going to be lower in comparison to Marinated. In order to determine the best comps, we decided to take a mull-faceted approach. For one, we determine the statistical significance (analysis is later on in this report) of each of the betas to eliminate some of the comps.Through that analysis, we determined that E*Trade, Ma cromedia, and Netscape did not have enough history to be statistically significant. To further narrow the list, we also determined that Charles Schwab Corp. and Waterholes Investor Services were the most comparable firms since they both are discount brokerage firms with a very significant ploughshare of revenue and access from brokerage (99% for Charles Schwab and 82% for Waterholes) and they also both have debt (currently Waterholes has no debt but has historically) in their capital structure. As far as full service brokers, we feltRaymond James Financial and Paine Webber were good comps. Both firms had a large percentage of revenue coming from brokerage (51% for Raymond James and 46% for Paine Webber) and both firms carry some debt (especially Paine Webber) in their capital structure. We also decided to throw in Yahoo as a comps since Marinated is largely an internet based company. In the end, we determine an average of Charles Schwab Corp., Waterholes Investor Services, and Ya hoo made the best beta estimate. Ill. An important component of analyzing Marinades cost of capital is to use the betas of comparable firms.