Estimating the cost of capital: considerations for small business

Abstract

Purpose

For publicly traded firms, calculating the cost of capital is predicated typically on information from the financial markets. Small businesses do not have the necessary market‐based information. As an alternative to traditional proxy approaches, this paper argues for a multi‐criteria model to determine an appropriate equity risk premium, and thereby, a cost of capital.

Design/methodology/approach

The study proposes a multi‐criteria model – an analytical hierarchy process (AHP) – to determine the cost of capital for small businesses.

Findings

Since the three proxy methods are shown to have numerous shortcomings, the use of the AHP model is clearly a method to determine the equity risk premium and the cost of capital for small businesses.

Research limitations/implications

The model requires small business managers to identify all information sources for the required input data.

Originality/value

The article offers practical help to lenders and small businesses wishing to invest in new capital projects.

Citation

Palliam, R. (2005), "Estimating the cost of capital: considerations for small business", Journal of Risk Finance, Vol. 6 No. 4, pp. 335-340. https://doi.org/10.1108/15265940510613660