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Ameritrade formed in 1971, was the pioneer in the deep-discount brokerage sector and also the first to offer
many new services that changed the way individual investors managed their portfolio. The average ROE during 1975
to 1996 was 40% all year. In 1997, Ameritrade raised $22.5 million in public offering to continue its long tradition of
technology enhancement and invest in branding.
Ameritrades main revenue sources were directly linked to stock market. Of its revenue were from
transaction and net interest. Investor generally curtailed trading activity and their borrowing in response to sustained
downward movements in the stock market. A substantial decline in the stock market could therefore lead to a steep
decline in Ameritrades brokerage commission and net interest.
Joe Ricketts, Chairman and CEO of Ameritrade, wanted to improve the companys competitive position in
deep-discount brokerage by taking advantage of emerging economies of scale. This required Ameritrade to grow its
customer base by substantial investments in technology to improve service and capacity, advertising and price
cutting. Large expenditures required to implement this strategy.
Ameritrade decided to offering low cost by reduced commissions from $29.95 to $8.00 per trade for all
internet market. There were no major player implementing low brokerage cost strategy even consumer are mostly
price sensitive. In addition, up to $100M budget would spend on technology enhancements. This strategy believed to
prevent system outages and increase trade execution speed. Advertising budget would also increase to $155M for
1998 and 1999 fiscal year combined.
To gauge the impact of Rickettss plan in this substantial investment, some accounting for the projects risk
is needed. Value can only created if the investment returned more than it cost and the investors would demand a
return that reflected the riskiness of their investment. Ricketts believed that CEO should tried to maximize
shareholder value, and he would invested if the expected returns on investment were greater than the cost of capital,
even there was a chance of bankrupting the firm. Ricketts was expected a return on the order of 30% to 50 % but
some members were not optimistic given an estimation of merely 10% to 15% for the return.
Furthermore, a CS First Boston analyst report employed a discount rate of 12% when evaluating Ameritrade
while Ameritrade CFO often used a 15% discount rate. In addition, the managers felt that a discount rate of 8-9% was
appropriate to the future profit estimates. A consultant was then hired by the CEO of Ameritrade to estimate the cost
of capital for Ameritrade. Another issue was Ameritrade was not clarify itself in the industry if it was a discount
brokerage firm or a technology/internet firm because ABN-AMRO valued Ameritrade as an internet firm.