Capital Budgeting in Arbitrage-Free Markets
AbstractIn capital budgeting problems future cash flows are discounted using the expected one period returns of the investment. In this paper we establish a theory that relates this approach to the assumption that markets are free of arbitrage. Our goal is to uncover implicit assumptions on the set of cash flow distributions that are suitable for the capital budgeting method. As results we obtain that the set of admissible cash flow distributions is large in the sense that no particular structure of the evolution of the distributions is implied. We give stylized examples that demonstrate that even strong assumptions on the return distributions do not restrain the shape of the cash flow distributions. In a subsequent analysis we characterize the cash flow distributions under the additional assumption of a deterministic dividend yield. In this case strong properties for the evolution of the distributions can be obtained.
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Bibliographic InfoPaper provided by Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät in its series Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Leibniz Universität Hannover with number dp-258.
Length: 12 pages
Date of creation: Jul 2002
Date of revision:
cost of capital; capital budgeting;
Find related papers by JEL classification:
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- D46 - Microeconomics - - Market Structure and Pricing - - - Value Theory
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