The determinants of cost of capital by industry, Evidence from companies quoted on Nairobi stock exchange

Abstract

In this study an attempt is made to determine the factors that drive the cost of capital in Kenya. An analysis is undertaken of the cost of capital based on a sample of 28 companies quoted on Nairobi Stock Exchange. Three models were used to determine the cost of equity and six for the overall cost of capital. From the analysis the cost of equity is around 9.67- 10.67 per cent and the overall cost of capital is roughly between 9.08 – 10.57 per cent. Step-wise multiple regressions are used to find the underlying determinants. Generally financial risk measured by gearing/leverage and age are found to be important determinant of the cost equity for the whole sample. For Agricultural sector growth and reserves are found to be among the important determinants of the cost of equity for the three models. For commercial and services sector the financial (for model 2) and business risks (for model 1 and 3) are important determinant while for industrial and allied sector growth stands out as the important factor. With regard to overall cost of capital for the whole sample, the key determinants are earnings growth and financial risks (gearing) for model 1 and 3. Sector wise reserves are the determinant of overall cost of capital under model 1 and 3. However model 1 has in addition fixed assets backing and financial risk as important determinants. Model 2 has earnings growth, size and business risk as the important determinant. For commercial and services sector, model 1 and 3 has business risks as important determinants while model 2 has financial risks (leverage) and reserves as the determinant of overall cost of capital.