earticle

영어

For decades, most business schools and companies have taught and behaved as if the capital asset pricing model (CAPM) can be used to estimate firms’ cost of equity capital for capital budgeting purposes. I examine whether the CAPM can be used for such purposes and prove that it cannot and must not. The most obvious reason for this rejection is the CAPM itself, which never allows for use in evaluating firms’ investment projects, if understood correctly. Using the CAPM for capital budgeting is essentially applying a pricebased theory to a cash-flow-based world and a perfect diversification model to undiversified firms, both of which are illogical jumps and never automatically guaranteed. I prove this in five independent rationales based on differences between securities and real investment, between stock prices and cash flows, between beta and standard deviation of returns, and based on problems in stocks with very low or even negative betas. In addition, a case illustration, two explanations for the ongoing inappropriate use of the CAPM for capital budgeting applications, a testable hypothesis, and a summary of previous surveys on the topic are also provided. This paper will provide theoretical rationales and practical interpretations of the significant differences between firms’ hurdle rates and the costs of capital reported in survey studies, in order to help practitioners or researchers establish more scientific and practical methods of determining appropriate discount rates for firms in the future.