Estimating the cost of equity capital for small companies: an empirical analysis of the effectiveness of an alternative method in calculating economic value added

Abstract

Abstract: Although initially developed for large corporations, economic value added (EVA) is a potential performance indicator to be used in small businesses (SME)s. EVA is calculated based on the cost of capital (equity and third party´s capital). Usually, the cost of equity capital is estimated using the classical Capital Asset Pricing Model (CAPM), whose parameters are estimated by market data. In general, the CAPM becomes impracticable in SMEs due to the scarcity or absence of stocks traded on the stock exchange. As literature presents some alternative methods to calculate the cost of equity for small private companies, the objective of this study is to evaluate the effectiveness of the alternative method proposed by Boudreaux et al. (2011) compared to the classical CAPM, when both methods are used to calculate the EVA indicator. From a sample composed of 34 companies listed on the Brazilian stock exchange (B3), the results show that the method is useful for estimating the cost of equity capital in the calculation of the EVA indicator. Keywords: Small businesses; SME; EVA indicator; Cost of equity capital; Cost of capital; Capital Asset Pricing Model; CAPM.