The flow-to-equity method uses
A)cash flows to equity, after interest and after taxes, and the cost of equity capital as the discount rate.
B)the cost of equity capital as the discount rate and the weighted average cost of capital for discount rate.
C)cash flows to equity, after interest and after taxes, and the weighted average cost of capital for discount rate.
D)the cost of equity capital as the discount rate and after-tax cash flows without considering interest and dividend payments.

Question

Quizplus · Accepted Answer

The flow-to-equity method is used to calculate the equity value of a company by discounting the cash flows that are available to equity holders after interest and taxes. The discount rate used in this method is the cost of equity capital. Hence, Option A is the correct answer as it uses both these inputs for arriving at the equity value. Option B is incorrect as it uses the weighted average cost of capital as the discount rate, which is not appropriate for equity valuation. Option C is incorrect as it does not use the cost of equity capital as the discount rate. Option D is incorrect as it does not consider interest payments, which is factored in the cash flows available to equity holders.

The Flow-To-Equity Method Uses