Market Value Maximization, After-Tax Profit and the Cost of Capital of Entrepreneurial Firms

Abstract

This paper examines the implications of various costs of capital on the market value and profit of entrepreneurial firms. Specifically, four costs were identified as follows: cost of debt (kd), cost of equity (ke), cost of retained earnings (kr), and weighted average cost of capital (ko). Ten-year time series and cross sectional data were collected from ten entrepreneurial firms quoted in the alternative investment markets category of Nigeria Stock Exchange. Two panel data regression models were formulated with two dependent variables (market value and net profit), and four independent variables (kd, ke, kr, and ko). Random effect model (REM) was preferred on two grounds: first, the intercept for each model bearing the cross-section effect was treated as random variable with a mean value of I, and second, there is no correlation between the individual or cross-section error component έi and the regressors ( ). We found that market value responds significantly to changes in ke and kr. Profitability was not found to have responded to changes in any particular cost in a statistically significant measure even at p ≤ 0.1. It was concluded that values of capitalized funds depend more on the vagaries of market forces than on profitability prospects of the firms’ assets.