'Investment and Market Risk Premium\r'

' hail of Capital at Ameritrade Day 1 1. What factors should Ameritrade management aim when evaluating the proposed advertising program and engine room upgrades? wherefore? -They should see how r counterbalanceues have changed after adopting the saucily ad program and technology upgrades -They contend to see ROI for their investments over time 2. How ro role the Capital asset Pricing model be used to label the bell of capital (required break) for calculating the net expression measure out of a projects cash consorts? it provide help us determine the Cost of capital or discount put which we can use to answer for NPV, in other terms the numerator get out neer change (FCF), yet the denominator will establish on the speak to of capital3. What is the estimate of the unhazardous prise that should be employed in calculating the hail of capiual for Ameritrades proposed investment? †the gamble free rate should be the T-bills rate or the average annualized or ganic annual returns on US presidency securities = 3. %. In my opinion, we should use the peril-free rate make up to yield of 20-year US government securities, because it is semipermanent capital investment. We may use 30-year rate, however we ar investing in technology, and concerning the stop number of technological enhancements, 20-year rate is optimal. So it is 6,69% 4. What is the estimate of the grocery attain premium that should be employed in calculating the cost of capital for Ameritrades proposed investment? Market assay of infection PremiumThree distinct concepts are part of commercialise guess premium: 1) Required food securities industry put on the report premium: the return of a portfolio over the luck-free rate (such as that of exchequer bonds ) required by an investor; 2) diachronic grocery risk premium: the historic differential return of the market over treasury bonds; and 3) Expected market risk premium: the judge differential return of the ma rket over treasury bonds. likewise called equity premium, market premium and risk premium.Market Risk Premium = Expected cede of the Market †Risk-Free Rate The expected return of the market can be based on the S;P 500, for example, while the risk-free rate is a lot based on the current returns of treasury bonds. First to find the Expected mother of the market, from parade 6, We take the aggregate line of stage business market and multiply by 12: = 15. 71% The Risk-free rate is 3. 8% =;gt; The market risk premium= 15. 7 †3. 8 = 11. 9% (That is why we may use the difference between US Government Securities rate (6,69%)and historical medium-large Company Stocks annual returns.But we have 2 numbers: during1950-96 and 1929-96. The difference between them is 1,3%. I think that we should useâ€Å" younger” value of 14%, because the years 1930-1949, of course, were under market economy, but at the homogeneous time there were not so static laws, a Second World fi ght passed, many companies at that time worked for government orders, so this number may be a bit out of boilersuit tendencies. ) 5. In principle, how would one go nigh determining of import for purposes of calculating the cost of capital for Ameritrades proposed investment?TO attend important for cost of capital, or adjunct beta: We need to find first the righteousness Beta = by regressing var. returns over market returns and it will therefore be the tip. We also need to calculate the market value of the equity of the firm which is the harm per share multiplied by the total number of shares outstanding (see attached notes) A cost of capital is a weight down average of the cost of debt and equity. Likewise, the asset beta is the weighted average betas of debt and equity. We use market value proportions of debt and equity (see CAPM, p. 476). Ba = (D/D+E)BetaD+ (E/D+E)BetaEIt is common to assume that debt has no relationship to market risk; that BetaD=0 Empirical studies of corporate debt returns suggest it would be better to assign some market-related risk to corporate debt; and use estimates ranging from 0. 20 to 0. 30. To function BetaE, the equity beta for Ameritrade, we would normally extend a regression of equity returns on stock market returns. That is, we would estimate the slope of the line that best fits: Unfortunately, Ameritrade had their IPO (Initial procure Offer) in March of 1997, so there is not enough data at the time of the case to calculate a reliable beta estimate.So instead, we will look at parallel with(predicate) firms. Firms in the same industry pursuing the same types of projects will have the same sorts of risks, thus their asset betas will be approximately the same. The returns we calculate for these firms, based on stock legal injury movement, dividends, and stock splits, are their equity betas. These are influenced by the degree of leverage severally friendship is using (recall that higher leverage leads to highe r ROE, EPS and DPS, but also leads to greater variability in earnings).Knowing the amount of debt in their capital complex body parts (at market values), we can calculate the asset beta for each comparable firm. Then we will average these to use as a proxy for Ameritrade’s asset beta Note: An component that mediates sales and exchanges between securities buyers and sellers at even lower commission rates than those offered by a regular discount gene . As one might expect, deeply discount brokers also provide less services to clients than standard brokers; such brokers typically provide little more than the fulfilment of stock and option trades, charging a even fee for each.The problem that must be overcome in determining the writ of execution decision is the uncertainty of the cost of capital. separate manners of Estimating Cost of Equity Capital: •The EP Method r = EPS / Stock Price •The ageless Growth (Gordon) Model r = DIV1 / P 0 + g compute g from ear nings, dividend, or cash flow emersion or use the sustainable reaping estimate ? Equity Betas, the relationship of a given equity’s risk to that of the larger market, reflects two kinds of risk â€The risk of the business itself â€The risk that the debt a business has will prevent cash flow to equity ?We can de-lever these equity betas to flake off out financial risk associated with leverage and find the implied beta for the business itself (asset beta) â€Asset beta measures the business risk only and does not change with capital structure ? Often, the best way to estimate a forward looking asset beta for a company is to take a median of its industry peers asset betas (historically calculated) since one-time company events in the past will be averaged out ? We can then find the equity beta for the company by re-levering the industry asset beta to the bulls eye debt / cap ratio of the company ? represent 4 provides various choices of comparable firms. Which firms d o you recommend as the appropriate benchmarks for evaluating the risk of Ameritrade’s planned advertising and technology investments? Determine the betas for these firms. Let us go that Charles Schwab is a comparable firm. Their price changes, dividends,and stock split information for 1992-1996 is in confront 5. If there were no stock split, thereturn, compared to the antecedent(prenominal) period, is given by: For example, if the price the previous period was $100, then wentup to $104, and in addition had a dividend of $8, the return would be +0. 12, or 12%.In ashort time period, the returns will be much closer to 0. If there is an X for y stock split, use the prescript: Copy the Return values into Exhibit 6 alongside the appropriate dates, then regress theSchwab returns against the value-weighted NYSE returns for the same period. The slopeof the line is the equity beta. Do this for the other comparable firms. Calculate the asset betas using the formula inquestion 5 (t wice, once with Beta D = 0 and once with 25. 0). Average the results. This should be a good estimate of Ameritrade’s asset beta. Finally, put these results back into the equality in #2 to estimate Ameritrade’s cost of capital\r\n'