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NBER Working Papers and Publications
|February 2011||The Cross-Section of Hurdle Rates for Capital Budgeting: An Empirical Analysis of Survey Data|
with Ravi Jagannathan, Vefa Tarhan: w16770
Whereas Poterba and Summers (1995) find that firms use hurdle rates that are unrelated to their CAPM betas, Graham and Harvey (2001) find that 74% of their survey firms use the CAPM for capital budgeting. We provide an explanation for these two apparently contradictory conclusions. We find that firms behave as though they add a hurdle premium to their CAPM based cost of capital. Following McDonald and Siegel (1986), we argue that the hurdle premium depends on the value of the option to defer investments. While CAPM explains only 10% of the cross-sectional variation in hurdle rates across firms, variables that proxy for the benefits from the option to wait for potentially better investment opportunities explain 35%. Estimates of our hurdle premium model parameters imply an equity premium ...
|January 2002||Do We Need CAPM for Capital Budgeting?|
with Ravi Jagannathan: w8719
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.
Published: Ravi Jagannathan & Iwan Meier, 2002. "Do We Need CAPM for Capital Budgeting?," Financial Management, Financial Management Association, vol. 31(4), Winter. citation courtesy of