There is a high potential for small-scale and medium scale wood-fired cogeneration in Estonia. The purpose of this research is to define the eligible capacity for wood fuel based cogeneration plant operating on the base of district heating systems in small towns. Results were checked and approbated by economical and environmental factors. Two optimal sizing methods were used: maximizing of amount of heat year-round while working at full installed capacity and maximizing of amount of heat year-round while working with partial loads. Results of defining optimal capacities for wood-fired cogeneration plants in small Estonian towns showed that method of maximizing of amount of heat year-round while working with partial loads is more adequate to real situation.