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

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.