Correct or incorrect application of CAPM? Correct or incorrect decisions with CAPM?

Magni, Carlo Alberto (2007): Correct or incorrect application of CAPM? Correct or incorrect decisions with CAPM? Forthcoming in: European Journal of Operational Research

Abstract

This paper focuses on inconsistencies arising from the use of NPV and CAPM for capital budgeting. It shows that (i) CAPM capital budgeting decision-making based on disequilibrium NPV is deductively inferred by the Capital Asset Pricing Model, (ii) the use of the disequilibrium NPV is widespread in finance both as a decision rule and as a valuation tool, (iii) the disequilibrium NPV does not guarantee additivity nor consistency with arbitrage pricing, so that it is unreliable for valuation, (iv) Magni’s (2002, 2007a, forthcoming) criticism of the NPV criterion refers to the disequilibrium NPV, and De Reyck’s (2005) project valuation method, on the basis of which Magni’s criticism to NPV is objected, leaves decision makers open to arbitrage losses and incorrect decisions.

• Item Type: MPRA Paper
• Institution: Dipartimento di Economia Politica, Università di Modena e Reggio Emilia, Italy
• Language: English
• Keywords: Corporate finance; investment analysis; Net Present Value; Capital Asset Pricing Model; disequilibrium; decision; valuation; nonadditivity; arbitrage
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; 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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