NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Do We Need CAPM for Capital Budgeting?

Ravi Jagannathan, Iwan Meier

NBER Working Paper No. 8719
Issued in January 2002
NBER Program(s):   AP   CF

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.

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Published: Ravi Jagannathan & Iwan Meier, 2002. "Do We Need CAPM for Capital Budgeting?," Financial Management, Financial Management Association, vol. 31(4), Winter.

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