Investment and Market Risk Premium
Cost of Capital at Ameritrade Day 1
1. What factors should Ameritrade management consider when evaluating the proposed advertising program and technology upgrades? Why?
- They should see how revenues have changed after adopting the new ad program and technology upgrades
- They need to see ROI for their investments over time
2. How can the Capital Asset Pricing Model be used to estimate the cost of capital (required return) for calculating the net present value of a project 's cash flows?
- it will help us determine the Cost of capital or discount rate which we can use to calculate NPV, in other terms the numerator will never change (FCF), only the denominator will based on the cost of capital
3. What is the estimate of the risk-free rate that should be employed in calculating the cost of capiual for Ameritrade 's proposed investment?
- the risk free rate should be the T-bills rate or the average annualized total annual returns on US government securities = 3.8%.
In my opinion, we should use the risk-free rate equal to yield of 20-year US government securities, because it is long-term capital investment. We may use 30-year rate, but we are investing in technology, and concerning the speed of technological enhancements, 20-year rate is optimal. So it is 6,69%
4. What is the estimate of the market risk premium that should be employed in calculating the cost of capital for Ameritrade 's proposed investment?
Market Risk Premium
Three distinct concepts are part of market risk premium:
1) Required market risk premium: the return of a portfolio over the risk-free rate (such as that of treasury bonds ) required by an investor;
2) Historical market risk premium: the historical differential return of the market over treasury bonds; and
3) Expected market risk premium: the expected differential return of the market over treasury bonds.
Also called equity premium, market premium and risk premium.
Market Risk Premium = Expected Return of the Market –
1. What factors should Ameritrade management consider when evaluating the proposed advertising program and technology upgrades? Why?
- They should see how revenues have changed after adopting the new ad program and technology upgrades
- They need to see ROI for their investments over time
2. How can the Capital Asset Pricing Model be used to estimate the cost of capital (required return) for calculating the net present value of a project 's cash flows?
- it will help us determine the Cost of capital or discount rate which we can use to calculate NPV, in other terms the numerator will never change (FCF), only the denominator will based on the cost of capital
3. What is the estimate of the risk-free rate that should be employed in calculating the cost of capiual for Ameritrade 's proposed investment?
- the risk free rate should be the T-bills rate or the average annualized total annual returns on US government securities = 3.8%.
In my opinion, we should use the risk-free rate equal to yield of 20-year US government securities, because it is long-term capital investment. We may use 30-year rate, but we are investing in technology, and concerning the speed of technological enhancements, 20-year rate is optimal. So it is 6,69%
4. What is the estimate of the market risk premium that should be employed in calculating the cost of capital for Ameritrade 's proposed investment?
Market Risk Premium
Three distinct concepts are part of market risk premium:
1) Required market risk premium: the return of a portfolio over the risk-free rate (such as that of treasury bonds ) required by an investor;
2) Historical market risk premium: the historical differential return of the market over treasury bonds; and
3) Expected market risk premium: the expected differential return of the market over treasury bonds.
Also called equity premium, market premium and risk premium.
Market Risk Premium = Expected Return of the Market –