CAPM‐based capital budgeting and nonadditivity

Purpose – In investment decision making, the net present value (NPV) rule is often used alongside the well‐known capital asset pricing model (CAPM). In particular, the use of disequilibrium NPV is endorsed in corporate finance for both valuation and decision. The purpose of this paper is to test the reliability of this approach to capital budgeting valuations and decisions. Design/methodology/approach – The use of disequilibrium values for computing a project's NPV is considered, and the consistency with the CAPM is checked. The resulting valuation and decision are contrasted with the no‐arbitrage principle, which is universally considered a benchmark for rationality. Findings – The paper finds that the disequilibrium NPV is logically deducted from the CAPM for decision‐making purposes. However, this NPV provides nonadditive values, which makes it inconsistent with the no‐arbitrage principle. Practical implications – The use of the CAPM+NPV procedure for valuing projects is invalid if disequilibrium values are used. Its use for decision making is logically valid but practically unsafe, because decision makers may frame equivalent courses of action in different ways, resulting in different decisions, which implies that they may incur arbitrage losses. Originality/value – The literature does not distinguish between equilibrium and disequilibrium NPV nor between valuation and decision. This paper explicitly makes this distinction and the resulting consequences are highlighted.