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    Do we need CAPM for capital budgeting?

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    Read the article "Do we need CAPM for capital budgeting?" Do you agree or disagree with the authors' position? Why or why not? Discuss the characterization of Jagannathan and Meler's assumptions. Are they valid?

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    Solution Preview

    The Capital Asset Pricing Model (CAPM) is used by most big business as a more risk adverse method of determining the preferred
    security in which to invest. Jagannathan and Meler indicated that if a business has to decide among a number of securities
    or portfolios, and the net present values of each security or portfolio clearly points to one of them, then that business could use the NPV
    method to determine the cost of capital. Then the authors go on to say that determining cost of capital is not the critical input in making
    the decision to buy a particular set of securities. CAPM uses the expected return of the securities considered, because it equals the rate ...

    Solution Summary

    This is a discussion of a paper by finance experts which considers the reasons why the CAPM method is used by so many big business financial officers when it could, by itself, lead to bad decisions. It discusses the use of the method, not to make decisions, but to determine when employ strategies that will result in making the best decisions when considering the capital purchase of securities or portfolios.