Economic profit, NPV, and CAPM: Biases and violations of Modigliani and Miller's Proposition I

MPRA Paper from University Library of Munich, Germany

Abstract: The notion of Net Present Value (NPV) is thought to formally translate the notion of economic profit, where the discount rate is the cost of capital. The latter is the expected rate of return of an equivalent-risk 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 are not equivalent if the standard NPV+CAPM is employed: NPV-minded agents are open to framing effects and to arbitrage losses, which imply violations of Modigliani and Miller's Proposition I. The standard notion of disequilibrium (present) value, deductively derived from the CAPM by several authors, should therefore be dismissed.

Keywords: Capital Asset Pricing Model; net present value; economic profit; disequilibrium; framing effects; arbitrage; Modigliani and Miller's Proposition I (search for similar items in EconPapers)
JEL-codes: G10 G11 G12 G30 G31 G32 (search for similar items in EconPapers)
Date: 2005-12, Revised 2008-02-27
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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https://mpra.ub.uni-muenchen.de/7377/1/MPRA_paper_7377.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/9276/1/MPRA_paper_9276.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/9373/1/MPRA_paper_9373.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/11399/1/MPRA_paper_11399.pdf revised version (application/pdf)

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