The most appropriate discount rate to use when applying the Operating Free Cash Flows model is the firm's
A) required rate of return based on the capital asset pricing model (CAPM).
B) required rate of return based on the dividend discount model (DDM).
C) weighted average cost of capital (WACC).
D) historical cost of debt and equity.
E) All of these are correct.

Question

Quizplus · Accepted Answer

The most appropriate discount rate to use when applying the Operating Free Cash Flows model is the weighted average cost of capital (WACC). This is because the WACC is the rate that represents the required return that the company's providers of capital require for their investment. It takes into account the cost of debt and the cost of equity and reflects the risk associated with the investment. This makes it a more accurate representation of the firm's cost of capital, compared to the required rate of return based on the CAPM or DDM, which only take into account the cost of equity. Historical costs of debt and equity may not represent the current cost of capital and can lead to inaccurate valuations.

The Most Appropriate Discount Rate to Use When Applying the Operating