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CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation

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  • Magni, Carlo Alberto

Abstract

This paper deals with the use of the CAPM for capital budgeting purposes. Four different measures are deductively drawn from this model: the disequilibrium Net Present Value, the equilibrium Net Present Value, the disequilibrium Net Future Value, the equilibrium Net Future Value. While all of them may be used for accept-reject decisions, only the equilibrium Net Present Value and the disequilibrium Net Future Value may be used for valuation, given that they are additive. However, despite their additivity, the latter are not always reliable metrics, because they do not signal arbitrage opportunities whenever there is some state of nature for which they are decreasing functions with respect to the end-of period cash flow. In this case, the equilibrium value of a project is not the price it would have if it were traded in the security market. This result is the capital-budgeting counterpart of Dybvig and Ingersoll’s (1982) result.

Suggested Citation

  • Magni, Carlo Alberto, 2007. "CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation," MPRA Paper 5468, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:5468
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    File URL: https://mpra.ub.uni-muenchen.de/15786/1/MPRA_paper_15786.pdf
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    References listed on IDEAS

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    3. Bierman, Harold, Jr & Hass, Jerome E, 1973. "Capital Budgeting Under Uncertainty: A Reformulation," Journal of Finance, American Finance Association, vol. 28(1), pages 119-129, March.
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    6. Mossin, Jan, 1969. "Security Pricing and Investment Criteria in Competitive Markets," American Economic Review, American Economic Association, vol. 59(5), pages 749-756, December.
    7. Magni, Carlo Alberto, 2007. "Project valuation and investment decisions: CAPM versus arbitrage," MPRA Paper 14525, University Library of Munich, Germany.
    8. Hamada, Robert S, 1969. "Portfolio Analysis, Market Equilibrium and Corporation Finance," Journal of Finance, American Finance Association, vol. 24(1), pages 13-31, March.
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    10. Senbet, Lemma W & Thompson, Howard E, 1978. "The Equivalence of Alternative Mean-Variance Capital Budgeting Models," Journal of Finance, American Finance Association, vol. 33(2), pages 395-401, May.
    11. Dybvig, Philip H & Ingersoll, Jonathan E, Jr, 1982. "Mean-Variance Theory in Complete Markets," The Journal of Business, University of Chicago Press, vol. 55(2), pages 233-251, April.
    12. Ekern, Steinar, 2006. "A Dozen Consistent CAPM-Related Valuation Models - So Why Use the Incorrect One?," Discussion Papers 2006/6, Norwegian School of Economics, Department of Business and Management Science, revised 25 Apr 2007.
    13. Stapleton, Richard C, 1974. "Capital Budgeting under Uncertainty: A Reformation: Comment," Journal of Finance, American Finance Association, vol. 29(5), pages 1583-1584, December.
    14. Magni, Carlo Alberto, 2007. "Project selection and equivalent CAPM-based investment criteria," MPRA Paper 14526, University Library of Munich, Germany.
    15. Litzenberger, Robert H. & Budd, Alan P., 1970. "Corporate Investment Criteria and the Valuation of Risk Assets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 5(4-5), pages 395-419, December.
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    Cited by:

    1. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    2. Magni, Carlo Alberto, 2005. "Theoretical Flaws In The Use Of The Capm For Investment Decisions," MPRA Paper 6330, University Library of Munich, Germany, revised Nov 2007.
    3. Magni, Carlo Alberto, 2005. "Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I," MPRA Paper 7359, University Library of Munich, Germany, revised 27 Feb 2008.

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    More about this item

    Keywords

    Capital budgeting; investment appraisal; project; risk-adjusted rate of return; CAPM; equilibrium; disequilibrium; present value; future value; decision; valuation; cost; risk;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G3 - Financial Economics - - Corporate Finance and Governance
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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