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CAPM-based capital budgeting and nonadditivity

Listed author(s):
  • Magni, Carlo Alberto

This paper deals with the CAPM-derived capital budgeting criterion, and in particular with Rubinstein’s (1973) criterion, according to which a project is profitable if the project rate of return is greater than the risk-adjusted cost of capital, where the latter depends on the project’s disequilibrium systematic risk. It is shown that the disequilibrium net present value implied by this criterion, widely used in corporate finance, is nonadditive. Four proofs are provided: (i) a counterexample taken from Copeland and Weston (1988), (ii) a modus-tollens argument showing that this notion of NPV is incompatible with additivity, (iii) a formalization showing that this NPV does not fulfil the principle of description invariance (iv) an example showing that CAPM-minded evaluators may incur arbitrage losses.

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File URL: https://mpra.ub.uni-muenchen.de/7290/3/MPRA_paper_7290.pdf
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File URL: https://mpra.ub.uni-muenchen.de/7317/4/MPRA_paper_7317.pdf
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File URL: https://mpra.ub.uni-muenchen.de/7384/1/MPRA_paper_7384.pdf
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File URL: https://mpra.ub.uni-muenchen.de/8936/1/MPRA_paper_8936.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 7290.

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Date of creation: Mar 2006
Handle: RePEc:pra:mprapa:7290
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  1. Hamada, Robert S, 1969. "Portfolio Analysis, Market Equilibrium and Corporation Finance," Journal of Finance, American Finance Association, vol. 24(1), pages 13-31, March.
  2. 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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