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A Note on Estimating the Cost of Capital for the Undiversified Business Owner

Author

Listed:
  • Kent A. Hickman

    (Gonzaga University)

  • Clarence Barnes

    (Gonzaga University)

  • John Byrd

    (Ft Lewis College and Byrd Hickman & Associates)

Abstract

About 70 percent of businesses are organized as sole proprietorships, and many business owners are not well-diversified, yet the finance discipline is largely silent regarding how to estimate the opportunity cost of capital for undiversified investors. In this paper, the Capital Market Line (CML) is presented as the appropriate vehicle for estimating such an investor’s return requirement. Recognizing the applicability of the CML allows the undiversified investor’s exposure to an investment’s total risk to be objectively linked to the market price of risk. Knowing the appropriate return requirement is useful for valuation and capital budgeting purposes.

Suggested Citation

  • Kent A. Hickman & Clarence Barnes & John Byrd, 1995. "A Note on Estimating the Cost of Capital for the Undiversified Business Owner," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 4(2), pages 191-196, Fall.
  • Handle: RePEc:pep:journl:v:4:y:1995:i:2:p:191-96
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    References listed on IDEAS

    as
    1. Fuller, Russell J & Kerr, Halbert S, 1981. "Estimating the Divisional Cost of Capital: An Analysis of the Pure-Play Technique," Journal of Finance, American Finance Association, vol. 36(5), pages 997-1009, December.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Cost of Capital; Entrepreneur; Small Business; Undiversified; Diversification;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups

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