Project selection and equivalent CAPM-based investment criteria

Magni, Carlo Alberto (2007): Project selection and equivalent CAPM-based investment criteria. Published in: Applied Financial Economics Letters , Vol. 3, No. 2 (2007): pp. 165-168.

Abstract

This article shows that the Capital Asset Pricing Model-based capital budgeting criteria proposed by Tuttle and Litzenberger (1968), Mossin (1969), Hamada (1969), Stapleton (1971), Rubinstein (1973), Bierman and Hass (1973) and Bogue and Roll (1974) are equivalent. They all state that a project is profitable if its internal rate of return is greater than the riskadjusted cost of capital, where the latter is given by the sum of the risk-free rate and a risk-premium which is a function of the systematic risk of the project, itself a function of the project cost.

• Item Type: MPRA Paper
• Language: English
• Keywords: Capital budgeting, investment decisions, capital asset pricing model, equivalence
• Subjects: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; G - Financial Economics > G3 - Corporate Finance and Governance > G30 - General; G - Financial Economics > G1 - General Financial Markets > G10 - General

References

Bierman, H. and Hass, J. E. (1973), Capital budgeting under uncertainty: a reformulation. Journal of Finance, 28(1), 119–129.

Bierman, H. and Hass, J. E. (1974), Reply, Journal of Finance, 29(5), 1585.

Bogue, M. C. and Roll, R. (1974), Capital budgeting of risky projects with ‘imperfect markets’ for physical capital, Journal of Finance, 29(2), 601–613, May.

Hamada, R. S. (1969), Portfolio analysis, market equilibrium and corporation finance, Journal of Finance, 24(1), 13–31, March.

Litzenberger, R. H. and Budd, A. P. (1970), Corporate investment criteria and the valuation of risk assets, Journal of Financial and Quantitative Analysis, 5(4), 395–418, December.

Magni, C. A. (2006). Project valuation and investment decisions: CAPM versus arbitrage. Applied Financial Economics Letters, 3, 1–4.

Mossin, J. (1969), Security pricing and investment criteria in competitive markets, American Economic Review, 59(5), 749–756, December. Rubinstein, M. (1973), A mean-variance synthesis of corporate financial theory, Journal of Finance, 28, 167–182, March.

Senbet, L. W. and Thompson, H. E. (1978), The equivalence of mean-variance capital budgeting models, Journal of Finance, 23(29), 395–401, May.

Stapleton, R. C. (1971), Portfolio analysis, stock valuation and capital budgeting decision rule for risky projects, Journal of Finance, 26(1), 95–117, March.

Stapleton, R. C. (1974), Capital Budgeting under Uncertainty: A Reformation: Comment, Journal of Finance, 29(5), 1583–1584.

Tuttle, D. L. and Litzenberger, R. H. (1968), Leverage, diversification and capital market effects on a risk-adjusted capital budgeting framework, Journal of Finance, 23(3), 427–443.