Do We Need CAPM for Capital Budgeting?

46 Pages Posted: 17 Jan 2002 Last revised: 6 Jan 2003

See all articles by Iwan Meier

Iwan Meier

HEC Montreal - Department of Finance

Ravi Jagannathan

Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF); Indian School of Business (ISB), Hyderabad

Multiple version iconThere are 2 versions of this paper

Date Written: January 2002

Abstract

A key input to the capital budgeting process is the cost of capital. Financial managers most often use the CAPM for estimating the cost of capital for which they need to know the market risk premium. Textbooks advocate using the historical value for the U.S. equity premium as the market risk premium. The CAPM as a model has been seriously challenged in the academic literature. In addition recent research indicates that the true market risk premium might have been as low as half the historical U.S. equity premium during the last two decades. If business finance courses have been teaching the use of the wrong model along with wrong inputs for twenty years, why has no one complained? We provide an answer to this puzzle.

Suggested Citation

Meier, Iwan and Jagannathan, Ravi, Do We Need CAPM for Capital Budgeting? (January 2002). NBER Working Paper No. w8719. Available at SSRN: https://ssrn.com/abstract=297345

Iwan Meier

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7 H2J 2K9
Canada
(514) 340-3198 (Phone)

Ravi Jagannathan (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
429 Andersen Hall
Evanston, IL 60208
United States
847-491-8338 (Phone)
847-491-5719 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

Indian School of Business (ISB), Hyderabad ( email )

Hyderabad, Gachibowli 500 019
India

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