CAPM and Capital Budgeting: Present versus Future, Equilibrium versus Disequilibrium, Decision versus Valuation

Abstract

This paper deals with the use of the CAPM for investment decisions and evaluations. 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. It is shown that all of them may be used for accept-reject decisions, but only the equilibrium Net Present Value and the disequilibrium Net Future Value may be used for valuation, given that they enjoy the additivity property. The two nonadditive indexes cannot be deducted from the CAPM assumptions if the decision problem “invest/no invest” is reframed as “invest in Z/invest in Y”. Despite their additivity, the equilibrium Net Present Value and the disequilibrium Net Future Value are unreliable for both valuation and decision, 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.