Is CAPM scientific or a naive attempt at pricing Assets in the guise of pricing Commodities.

Consider a company with constant cash flows of 100(for simplifying) for the next 5 years with a return on Investment of say 15%(opportunity cost which is return on competing investment if higher than what you have chosen), the economic value of it it is by Discounted cash flow method is, paying at the end of the year. Let the total investment in the company fixed assets be 100.

Year          Present value

1                                    100/(1+0.15)=  86.96   

2                                    100/(1+0.15)²=75.61

3                                    100/(1+0.15)³=65.75

4                                    100/(1+0.15)⁴=57.18

5                                    100/(1+0.15)⁵=49.72

Total                                335.22

In the above we see that the 86.96 used in the first year to generate the cash flow for the first year is recycled throughout the next 5 years but is double counted every year as a separate entity to come to the Economic value. The rationale they say it is the “time value”. 

Suppose if we invest the 335.22  the bottom entry in the first year at 15%, then the first year cash flow will be 385.03, which is what an Investor in the business is actually doing, paying 335.22 and again coming up with the 86.96 to invest making his total investment to 335.22+86.96=422.18 and get a return on investment of (100/422.18)100=23.68%. Before someone investing there the return on investment form above data used to be  (100/(100+86.96)100=53.49%. Even if the original physical plant investment was 200 then again the return on investment after sale of the enterprise for the economic value reduces the post sale return on investment.

We see in the hypothetical example above that the Economic value is calculated by double counting many times when only one counting will suffice to get the time value.

The reason given is the later Investor can recoup his investment in the due course of time, and if he keep running the enterprise at similar of increased efficiency till the life of the physical plant is extinguished can make more capital for himself beyond what he invested.

To avoid the double counting, it is usually in Economic Value calculations the Dividend is used instead of the whole cash flows plus the terminal value of the enterprise is calculated from the Capital Asset Pricing Model which is Price at the end of the 5^th year = Dividend at the end of 5^th year/(return on equity – growth rate).

The problem then is Capital Asset Pricing Model (CAPM)seem to be not rational in design for the reason that it follows the model of Keynsian “Commodity” Pricing where as Stocks are “Assets” . Moreover the β used to calculate the required return on equity depends on standard deviation of Normal Distribution of Market return where the data used for calculating the market return for future years is “unpredictable”.

CAPM  based return on equity = riskfree rate+β(return on market – riskfree rate), where β=Covariance of (standard deviation of market return to asset return)/(standard deviation of market teturn)². With these drawbacks for CAPM is it not time ripe enough to propound a more scientifically reliable CAPM, which cannot be falsified like the present one ?