A probability based approach to estimating cost of capital for small business

While discount rates of listed companies can be readily estimated using "be tas" and the Capital Asset Pricing Model, the same is not true for small bu siness. Entrepreneurs often have to rely on subjective assessments of the f inancial viability of their business ventures. This paper suggests an alter native to estimate the costs of capital for small businesses. Costs of capi tal are derived from the probability of success for similar business. These required rates of return can be used as minimum hurdle rates to assess the viability and profitability of the business under consideration. Since ris k neutrality is assumed of investors in this approach, the costs of capital established should only be regarded as minimum returns required by risk-av erse investors. Therefore, this suggested approach attempts to provide a re fined "rule-of-thumb" which may be of value to small business entrepreneurs and financiers, especially when detailed accounting and financial data of similar business are not readily available.