ACCA Strategic Professional · Advanced Financial Management · Valuation and the use of free cash flows
Which discount rate is appropriate when valuing a company's equity by discounting its free cash flow to equity (FCFE)?
The cost of equity is correct because FCFE is the cash left for shareholders after interest and debt flows, so it carries equity risk. WACC applies to FCFF, which belongs to all providers of finance.
- AThe cost of equityCorrect
- BThe weighted average cost of capital
- CThe after-tax cost of debt
- DThe risk-free rate
Explanation
FCFE is the cash flow after debt servicing and belongs to shareholders only, so it is discounted at the cost of equity. WACC is used for FCFF, which is available to all capital providers.
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