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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2006/6:
A Dozen Consistent CAPM-Related Valuation Models - So Why Use the Incorrect One?

Steinar Ekern ()

Abstract: Betas computed from returns based on investment cost rather than on market value, may give systematically inappropriate discount rates and numerically incorrect present values for nonzero NPVs and "mispriced" assets. The paper provides a self contained collection of a "baker's dozen" consistent CAPM-related methods, that all give correct valuation results. The models include approaches based on certainty equivalents, equilibrium and disequilibrium required discount rates, simplified discounting rules for particular cash flow formulations, as well as required adaptations to make valuations from more advanced valuation methods consistent with correct CAPM procedures. Additional issues and relations related to different betas are also discussed and partly extended. Derivations of the valuation methods are shown in an appendix. A running base case numerical example illustrates the various procedures.

Keywords: CAPM consistency; disequilibrium valuation; cost based betas; risk-adjusted discount rates; simple rules; mispricing; Jensen's alpha; (follow links to similar papers)

JEL-Codes: G11; G12; G31; (follow links to similar papers)

44 pages, May 30, 2006, Revised April 25, 2007

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