Cost of capital in SMEs

Abstract

Purpose -The purpose of this paper is to discuss the applicability of value based management (VBM) concepts for small to medium-sized enterprises (SMEs) and to identify obstacles for its implementation. Estimating cost of capital is central to all VBM concepts, it is hence intended to critically analyse approaches that allow estimating cost of capital for non-publicly traded firms. Design/methodology/approach -The paper is based on literature review and a case study approach. A case study on estimating the cost of capital has been conducted with a single manufacturing firm in Germany. Findings -VBM may provide useful management concepts for SMEs. Estimating the cost of capital has been found to be a critical element of implementing VBM concepts. Due to the absence of capital market data, cost of equity in SMEs has to be derived by means of alternative procedures. Results of a case study implicate that a combination of different methods may provide reasonable results in practice.Research limitations/implications -The applied research approach and the heterogeneity of the SME sector do not allow generalizing the results of this research. Originality/value -The paper addresses a major barrier for implementing VBM in SMEs. It proposes a combination of analogy and qualitative approaches for estimating the cost of equity in SMEs. Keywords Cost of capital, Small to medium-sized enterprises, Manufacturing industries, Germany, Value-based management, Weighted average cost of capital, Capital asset pricing model Paper type Research paper

Evaluation of Capital Cost: Long Run Evidence from Manufacturing Sector

“…Ward (1999) agrees that this method is widely used to calculate cost of capital. In Britzelmaier et al (2013) paper it is written that 75 % of financial professors suggest using CAPM to estimate cost of equity capital with regard to capital budgeting. Despite it's popularity, researchers express concern towards eligibility of CAPM.…”

“…In economic terms, it is the rate of return needed to make capital investment worthwhile, taking into account cost of alternative investment methods (Barth, 2009). Although large enterprises for managerial practices use WACC less frequently after the financial crisis, which began in 2008, capital cost measurement and use as a motivational device is still widely employed in small and medium size companies (Britzelmaier et. al., 2013).…”

“…Albanez (2015) analysed behavior of listed Brazilian companies and concluded that in periods of more expensive equity capital, companies restructured their capital with larger share of debt. Case study by Britzelmaier et al (2013) indicated that value-based management has become a key management approach for small and medium size companies, where WACC is used to determine cost of invested capital. Gupta et al (2018) stated that firm level governance affects cost of equity in common law countries with high levels of financial development.…”

Small Family Businesses: Innovation, Risk and Value

“…For small businesses however, this information may not be available. Several authors have suggested the use of alternative forms of beta calculation in order to work around this issues, such as the use of accounting betas, based on the historic accounting returns of the small business (Almisher and Kish 2000;St-Pierre and Bahri 2006) and the use of pure-play betas, based on market benchmarks of listed companies in similar industries (Bernd Britzelmaier et al 2013;Collier et al 2007;Fuller and Kerr 1981). Agency cost within small businesses (which is usually PP in nature) has an indirect impact on small business risk and by calculating the cost of capital for small businesses, the value of small business risk and its PP conflict exposure can be estimated.…”

Capital Structure Analysis to Optimize the Profitability of Msmes (Case Study on Msmes Hikmah in Sidoarjo, East Java, Indonesia)

“…Fred Weston, 1996) Seeing the development of MSMEs that continues to increase from year to year, this has not been accompanied by awareness of MSMEs actors in understanding and the importance of analyzing capital structure for their business activities. The use of capital structures in the MSME sector still tends to often use external sources of debt (Debt) which cause high costs of capital to be borne rather than using funding sources originating from internal sources, so that simple and easy to understand analysis is needed to help optimize the extent to which the business can using the composition of the right capital structure (Optimal) using the Weighted Average Cost Of Capital (WACC) analysis method (Britzelmaier, Kraus, Häberle, Mayer, & Beck, 2013). Weighted Average Cost Of Capital is the weighted average cost of capital for all financing sources that the company will use to finance long-term assets (David F. Scott, 2000).…”