Asked by Kalindi Schneider on May 06, 2024
Verified
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) required rate of return on equity or risk-free rate, depending on the debt level of the firm.
E) None of the options are correct.
FCFF Valuation Model
The FCFF Valuation Model estimates a company's value by using its Free Cash Flow to the Firm (FCFF), discounting the cash flows to their present value using the weighted average cost of capital.
WACC
Weighted Average Cost of Capital; the average rate of return a company is expected to pay its security holders to finance its assets, integrating debt and equity.
Discount Rate
The interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve's discount window.
- Identify the differences between the FCFE and FCFF valuation models, including the correct discount rates for each.
- Appraise the relevance of discount rates like WACC, needed equity return rate, and risk-free rate in value estimation models.
Verified Answer
LN
Leslie NungarayMay 09, 2024
Final Answer :
B
Explanation :
The Weighted Average Cost of Capital (WACC) is the most appropriate discount rate to use when applying a Free Cash Flow to the Firm (FCFF) valuation model because it reflects the overall cost of capital, including both debt and equity, which aligns with the perspective of the FCFF model that values the entire firm.
Learning Objectives
- Identify the differences between the FCFE and FCFF valuation models, including the correct discount rates for each.
- Appraise the relevance of discount rates like WACC, needed equity return rate, and risk-free rate in value estimation models.