Executive Summary: In mid-1997 Joe Ricketts the Chairman and CEO of Ameritrade, decided that Ameritrade’s new mission would be to become “the largest brokerage firm worldwide based on the number of trades.” In order to accomplish this mission Ameritrade would need to invest significantly in technology and advertising. This strategy would require large expenditures relative to Ameritrade’s existing capital. In order to gauge the financial impact of these large expenditures, there needed to be some accounting for the riskiness of the project. The average return on equity for Ameritrade from 1975 to 1996 was 40% and recent returns were much higher, with each of the most recent five years having larger returns than the 40% average.
Ricketts strategy called for price cutting, technology enhancements and increased advertising. They first reduced the commission on a trade from $29.95 to $8.00. They then budgeted $100 million for technology enhancements which also would increase trade execution speed. And, finally Ameritrade increased its advertising budget to $155 million for the 1998 and 1999 fiscal years combined. This plan would only be successful if the investment returned more than it cost. Ricketts believed that his role was to maximize shareholder value and he was committed to invest in this project if the expected returns on the investment were greater than cost of capital. But what was the cost of capital? 1. As a general rule of thumb, the projected present value of future cash flows should be greater than the costs using the company's cost of capital as the discounting factor. Both of the programs involve risk and so the expected returns from the company increase. The programs undertaken must be able to reasonably fulfill the expectations of returns of the investors. The company wants to increase advertising in order to become the leader in reliable online brokerage services. Thus, it should take into account the best means of increasing its customer base (television, ad, newspaper, and magazine, online, mailing) through focused groups and the cost per each. Ideally it should invest in