Magni, Carlo Alberto (2005): Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. Forthcoming in: The ICFAI Journal of Applied Finance
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Abstract
For one–period projects under certainty, the notion of Net Present Value (NPV) formally translates the notion of economic profit, where the discount rate is the cost of capital. Under uncertainty, the cost of capital is the expected rate of return of an equivalentrisk alternative that the investor might undertake and is often found by making recourse to the Capital Asset Pricing Model. This paper shows that the notions of disequilibrium NPV and economic profit for risky oneperiod projects are not equivalent: NPVminded agents are open to framing effects and to arbitrage losses, which imply violations of Modigliani and Miller’s Proposition I. The notion of disequilibrium (present) value, deductively derived from the CAPM by several authors and widely used in applied corporate finance, should therefore be dismissed
Item Type:  MPRA Paper 

Original Title:  Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I 
Language:  English 
Keywords:  Capital Asset Pricing Model, net present value, economic profit, disequilibrium, framing effects, arbitrage, Modigliani and Miller's Proposition I 
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 G  Financial Economics > G3  Corporate Finance and Governance > G32  Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill G  Financial Economics > G1  General Financial Markets > G10  General G  Financial Economics > G3  Corporate Finance and Governance > G30  General 
Item ID:  9373 
Depositing User:  Carlo Alberto Magni 
Date Deposited:  30 Jun 2008 07:23 
Last Modified:  27 Sep 2019 15:50 
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URI:  https://mpra.ub.unimuenchen.de/id/eprint/9373 
Available Versions of this Item

Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 19 Dec 2007 07:24)

Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 27 Feb 2008 15:00)

Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 28 Feb 2008 16:52)

Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 24 Jun 2008 01:41)
 Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 30 Jun 2008 07:23) [Currently Displayed]

Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 24 Jun 2008 01:41)

Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 28 Feb 2008 16:52)

Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I. (deposited 27 Feb 2008 15:00)