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

Abstract

This paper shows that a decision maker using the CAPM for valuing firms and making decisions may contradict Modigliani and Miller’s Proposition I, if he adopts the widely-accepted disequilibrium NPV. As a consequence, CAPM-minded agents employing this NPV are open to arbitrage losses and miss arbitrage opportunities. As a result, even though the use of the disequilibrium NPV for decision-making is deductively drawn from the CAPM, its use for both valuation and decision should be rejected.Firm value, Free Cash Flow, CAPM, Modigliani and Miller’s Proposition I, Net Present Value, disequilibrium, arbitrage, decision making