Question

The most appropriate discount rate to use when applying a FCFE valuation model is the:

Select one:

a. WACC

b. Risk-free rate

c. Required rate of return on equity or risk-free rate depending on the debt level of the firm

d. Cost of Debt

e. Cost of Equity

Answer 1

Answer - Required rate of return on equity or risk-free rate depending on the debt level of the firm.

Reason - The most appropriate Discounting rate when using free cash flow to equity valuation model is the rate of return on equity. This is because free cashflows are cashflows which a business generates and are available to be potentially distributed to equity shareholders. It is valued on the basis of rate required by the equity shareholders because at the end these cashflows potentially belongs to equity shareholders.