Asked by Trishton Belisle on Apr 27, 2024
Verified
The most appropriate discount rate to use when applying a FCFE valuation model is the
A) required rate of return on equity.
B) WACC.
C) risk-free rate.
D) None of the options are correct.
FCFE Valuation Model
A method used to estimate the value of a company by discounting its expected free cash flows to equity holders at an appropriate risk-adjusted rate.
Discount Rate
The discount rate is the interest rate used to determine the present value of future cash flows in discounted cash flow analysis, reflecting the cost of capital or risk of the cash flows.
Required Rate of Return on Equity
The minimum rate of return that investors expect from their stock investments, considering the risk involved.
- Differentiate between Free Cash Flow to Equity (FCFE) and Free Cash Flow to Firm (FCFF) valuation models and their appropriate discount rates.
- Evaluate the appropriateness of discount rates such as WACC, required rate of return on equity, and risk-free rate in valuation models.
Verified Answer
AH
Autumn HamiltonMay 01, 2024
Final Answer :
A
Explanation :
The FCFE (Free Cash Flow to Equity) valuation model calculates the value of equity, so the most appropriate discount rate is the required rate of return on equity. This rate reflects the return that equity investors expect for investing in the company, taking into account the risk of the equity investment.
Learning Objectives
- Differentiate between Free Cash Flow to Equity (FCFE) and Free Cash Flow to Firm (FCFF) valuation models and their appropriate discount rates.
- Evaluate the appropriateness of discount rates such as WACC, required rate of return on equity, and risk-free rate in valuation models.