Munich Personal RePEc Archive

Firm Value and the mis-use of the CAPM for valuation and decision making

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)

This is the latest version of this item.

[thumbnail of MPRA_paper_15688.pdf]

Download (242kB) | Preview


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.

Available Versions of this Item

Atom RSS 1.0 RSS 2.0

Contact us: mpra@ub.uni-muenchen.de

This repository has been built using EPrints software.

MPRA is a RePEc service hosted by Logo of the University Library LMU Munich.