The most appropriate discount rate to use when applying a FCFF valuation model is the ___________.
A)required rate of return on equity
B)WACC
C)risk-free rate
D)A or C depending on the debt level of the firm
E)none of the above

Question

Quizplus · Accepted Answer

The most appropriate discount rate to use when applying a FCFF valuation model is the weighted average cost of capital (WACC). This is because FCFF represents the cash flows available to all the providers of capital (equity and debt), and the WACC is the required rate of return that reflects the cost of all the sources of capital. The required rate of return on equity (choice A) only reflects the cost of equity, while the risk-free rate (choice C) only represents the cost of debt-free equity, which is not appropriate for FCFF valuation. The choice D is not always the best option because the optimal capital structure is not always known or stable. Therefore, WACC is the best choice for FCFF valuation.

The Most Appropriate Discount Rate to Use When Applying a FCFF