| What is the risk-free rate that should be used in calculating the cost of capital using the CAPM?
The risk-free rate should match the project horizaon of the potential investment. The Ameritrade case mentions near-term investments are being considered, including enhancements in technology and a 2 years advertising budget. The case also mentions that Ameritrade has a “long tradition of adopting the latest advances in technology”
Due to the 2 years advertising budget proposal and Ameritrade’s practice of investing in the lates technology (which could not have a prolonged useful life), the time horizon to determine the Cost of Capital for these investments is closer to 5 years. Therefore, the risk-free rate should reflect the anticipated 5 years bond yield of 6.22%. The 10, 20 or 30 year bonds are too long based on how rapidly things develop in the technology field, and the 3 months and 1 year bonds are not long enough to reflect the length of the investment (which will be at least 2 years based on the advertising dubdget being considered)
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