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Estimating the cost of capital: considerations for small business

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  • Ralph Palliam

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.

Suggested Citation

  • Ralph Palliam, 2005. "Estimating the cost of capital: considerations for small business," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 6(4), pages 335-340, September.
    • Handle: RePEc:eme:jrfpps:15265940510613660
    DOI: 10.1108/15265940510613660
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