Asset Valuation, Firm Investment, and Firm Diversification

Abstract

In Section I of the present paper, it is shown that Proposition I (relationship between income streams) and the irrelevancy of firm-investment diversification hold in the multiperiod case, with risky (as well as riskless) debt and with no assumption regarding which income-stream parameters (e.g. mean an variance) are used by investors in selecting portfolios. That is, no particular valuation equation is assumed. Proposition I is derived first , given homogeneous investor expectations, and then is extended to the case of heterogeneous expectations by adding a further assumption. In Section II, corporate taxes are introduced. Proposition I does not hold in this case. However, a similar proposition is derived and found to imply that diversification should not be a consideration for firm-investment policy even with corporate taxes. In establishing the results of Section I and II, it is assumed that capital markets are competitive with zero transaction costs and that, therefore, can be performed in the market. In Section III, the arbitrage assumption is briefly examined.

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