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

Magni, Carlo Alberto (2007): CAPM and capital budgeting: present versus future, equilibrium versus disequilibrium, decision versus valuation.

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.

• Item Type: MPRA Paper
• Institution: Dipartimento di Economia politica, University di Modena e Reggio Emilia, Italy
• Language: English
• Keywords: Capital budgeting; investment appraisal; project; risk-adjusted rate of return; CAPM; equilibrium; disequilibrium; present value; future value; decision; valuation; cost; risk
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; G - Financial Economics > G3 - Corporate Finance and Governance; 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

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