When conducting discounted cash flow (DCF)valuation using free cash flow to equity,the appropriate discount rate is:
A) Weighted average cost of equity
B) Risk-adjusted cost of equity
C) Cost of debt
D) Risk-adjusted cost of debt

Question

Quizplus · Accepted Answer

When valuing equity, the appropriate discount rate is the risk-adjusted cost of equity. This takes into account the risk of investing in the equity, and is calculated by adjusting the cost of equity (which reflects the opportunity cost of capital) for the additional risk. The Weighted Average Cost of Capital (WACC), which includes both equity and debt, is not appropriate for valuing equity. The cost of debt and risk-adjusted cost of debt is only relevant when valuing the firm as a whole or the debt specifically.

When Conducting Discounted Cash Flow (DCF)valuation Using Free Cash Flow