Do We Need CAPM for Capital Budgeting?

Meier, Iwan; Jagannathan, Ravi

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Do We Need CAPM for Capital Budgeting?

NBER Working Paper No. w8719

46 Pages Posted: 17 Jan 2002 Last revised: 30 Oct 2022

See all articles by Iwan Meier

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

There 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: 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