In the context of WACC, what factor could cause a smaller company to have a higher WACC?

A smaller company may have a higher Weighted Average Cost of Capital (WACC) primarily due to its capital structure, especially if it has more debt. While increased levels of debt can lower the overall WACC for larger, stable companies due to the tax shield associated with interest payments on debt, the situation is often different for smaller companies.

Smaller firms typically face a higher risk profile compared to larger, established companies. This increased risk arises from various factors, including less stable cash flows, limited access to financial markets, and greater vulnerability to economic downturns. As a result, lenders may require a higher return for the increased risk associated with lending to a smaller company. Consequently, the cost of debt for the smaller company increases, contributing to a higher WACC.

Furthermore, the equity portion of the WACC calculation can also be impacted. Investors often demand a higher rate of return on equity for smaller firms to compensate for the perceived additional risk they carry. Therefore, when assessing WACC for a smaller company with more debt, the increased cost of both debt and equity leads to a higher overall WACC, reflecting the company's riskier profile.