Magni, Carlo Alberto (2005): Firm Value and the mis-use of the CAPM for valuation and decision making. Forthcoming in: Applied Economics Research Bulletin (Peer-Reviewed Working Paper Series) (2009)
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The use of CAPM‐based disequilibrium betas and Net Present Value (NPV) for investment decisions and valuations is widespread in finance. Actually, its use is logically deducted from the CAPM assumptions. This paper deals with decisions about purchase of a firm and the related issue of firm valuation. In particular, it contrasts disequilibrium betas and NPVs with Modigliani and Miller’s Proposition I, and shows that disequilibrium betas and NPVs should not be used because they lead to irrational valuations and unreliable decisions; in particular, they lead decision makers to infringe Modigliani and Miller’s Proposition I. To prove the thesis, a counterexample is shown where two firms with same expected free cash flows are valued, one of which is levered, the other one is unlevered. A formal generalization is also provided. The results indicate that the use of disequilibrium NPV should be avoided, because valuations are incorrect and decisions are unsafe, leaving decision makers open to framing effects and arbitrage losses.
|Item Type:||MPRA Paper|
|Original Title:||Firm Value and the mis-use of the CAPM for valuation and decision making|
|Keywords:||Firm value, Free Cash Flow, CAPM, Modigliani and Miller’s Proposition I, Net Present Value, disequilibrium, arbitrage, decision making.|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates
G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity
M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics
|Depositing User:||Carlo Alberto Magni|
|Date Deposited:||12. Jun 2009 15:55|
|Last Modified:||14. Feb 2013 21:25|
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Firm Value and the mis-use of the CAPM for valuation and decision making. (deposited 07. Jan 2008 04:31)
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