Aim:
The aim of this case is to calculate the cost of capital (the OCC) that Ameritrade must use in evaluating projects. To do this, you must use the capital asset pricing model (CAPM). You would required to calculate an asset beta. While information for Ameritrade’s stock price is available, it is only available for a short period, and so must not be used in calculating a beta. Your solution must work along the following lines:
• Identify comparable companies.
• Using the stock price and returns data given to you, compute the asset betas of these comparable companies.
• Use these asset betas to calculate an asset beta for Ameritrade’s project.
• Use the CAPM to come up with an estimate of the OCC on Ameritrade’s project.
Note: The risk-free rate you must use in the SML refers to the risk-free rate over the same horizon as the project/investment you are considering. For projects/investments that last 3 months, for example, you must use the 3 month risk-free rate1. For projects that last 10 years, use the 10 year rate.
You might suppose that all debt betas are zero. Please check the sensitivity of your results to this assumption.