The use of CAPM‐based disequilibrium betas and Net Present Value (NPV) for investment decisionsand valuations is widespread in finance. Actually, its use is logically deducted from the CAPMassumptions. This paper deals with decisions about purchase of a firm and the related issue of firmvaluation. In particular, it contrasts disequilibrium betas and NPVs with Modigliani and Miller’sProposition I, and shows that disequilibrium betas and NPVs should not be used because theylead to irrational valuations and unreliable decisions; in particular, they lead decision makers toinfringe Modigliani and Miller’s Proposition I. To prove the thesis, a counterexample is shownwhere two firms with same expected free cash flows are valued, one of which is levered, the otherone is unlevered. A formal generalization is also provided. The results indicate that the use ofdisequilibrium NPV should be avoided, because valuations are incorrect and decisions are unsafe,leaving decision makers open to framing effects and arbitrage losses.

Magni, Carlo Alberto. "Firm value and the mis-use of the CAPM for valuation and decision making" Working paper, Applied Economics Research Bulletin Peer Reviewed Working Paper Series, 2009.

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

MAGNI, Carlo Alberto
2009

Abstract

The use of CAPM‐based disequilibrium betas and Net Present Value (NPV) for investment decisionsand valuations is widespread in finance. Actually, its use is logically deducted from the CAPMassumptions. This paper deals with decisions about purchase of a firm and the related issue of firmvaluation. In particular, it contrasts disequilibrium betas and NPVs with Modigliani and Miller’sProposition I, and shows that disequilibrium betas and NPVs should not be used because theylead to irrational valuations and unreliable decisions; in particular, they lead decision makers toinfringe Modigliani and Miller’s Proposition I. To prove the thesis, a counterexample is shownwhere two firms with same expected free cash flows are valued, one of which is levered, the otherone is unlevered. A formal generalization is also provided. The results indicate that the use ofdisequilibrium NPV should be avoided, because valuations are incorrect and decisions are unsafe,leaving decision makers open to framing effects and arbitrage losses.
2009
0
Magni, Carlo Alberto
Magni, Carlo Alberto. "Firm value and the mis-use of the CAPM for valuation and decision making" Working paper, Applied Economics Research Bulletin Peer Reviewed Working Paper Series, 2009.
File in questo prodotto:
Non ci sono file associati a questo prodotto.
Pubblicazioni consigliate

Licenza Creative Commons
I metadati presenti in IRIS UNIMORE sono rilasciati con licenza Creative Commons CC0 1.0 Universal, mentre i file delle pubblicazioni sono rilasciati con licenza Attribuzione 4.0 Internazionale (CC BY 4.0), salvo diversa indicazione.
In caso di violazione di copyright, contattare Supporto Iris

Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/11380/454805
Citazioni
  • ???jsp.display-item.citation.pmc??? ND
  • Scopus ND
  • ???jsp.display-item.citation.isi??? ND
social impact