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CMA Final · Strategic Performance Management and Business Valuation · Business Valuation Methods and Approaches

Which statement about the discounted cash flow (DCF) approach to valuing a firm using free cash flow to firm (FCFF) is correct?

FCFF belongs to all capital providers, so it is discounted at the weighted average cost of capital to give enterprise value. Net debt is then deducted to reach equity value. Cost of equity is used only for free cash flow to equity.

  1. AFCFF is discounted at the cost of equity to obtain equity value directly
  2. BFCFF is discounted at the weighted average cost of capital to obtain enterprise valueCorrect
  3. CFCFF is discounted at the cost of debt, because lenders are paid first
  4. DFCFF is discounted at the risk-free rate to avoid double counting risk

Explanation

FCFF is cash available to all capital providers, so it is discounted at the WACC to give enterprise value. Equity value is then obtained by subtracting net debt. Discounting at cost of equity is used for FCFE, not FCFF.

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