CAPM-based capital budgeting and nonadditivity

Carlo Alberto Magni

MPRA Paper from University Library of Munich, Germany

Abstract: This paper deals with the CAPM-derived capital budgeting criterion, and in particular with Rubinstein’s (1973) criterion, according to which a project is profitable if the project rate of return is greater than the risk-adjusted cost of capital, where the latter depends on the project’s disequilibrium systematic risk. It is shown that the disequilibrium net present value implied by this criterion, widely used in corporate finance, is nonadditive. Four proofs are provided: (i) a counterexample taken from Copeland and Weston (1988), (ii) a modus-tollens argument showing that this notion of NPV is incompatible with additivity, (iii) a formalization showing that this NPV does not fulfil the principle of description invariance (iv) an example showing that CAPM-minded evaluators may incur arbitrage losses.

Keywords: NPV; disequilibrium; CAPM; capital budgeting; nonadditivity (search for similar items in EconPapers)
JEL-codes: G11 G12 G31 M21 (search for similar items in EconPapers)
Date: 2006-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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https://mpra.ub.uni-muenchen.de/7290/3/MPRA_paper_7290.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/7317/4/MPRA_paper_7317.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/7384/1/MPRA_paper_7384.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/8936/1/MPRA_paper_8936.pdf revised version (application/pdf)

Related works:
Journal Article: CAPM‐based capital budgeting and nonadditivity (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:7290

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