{"id":17195,"date":"2021-07-08T11:26:54","date_gmt":"2021-07-08T11:26:54","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=17195"},"modified":"2026-06-30T18:37:16","modified_gmt":"2026-06-30T18:37:16","slug":"discount-rate-selection-in-relation-to-cash-flows","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/discount-rate-selection-in-relation-to-cash-flows\/","title":{"rendered":"Discount Rate Selection in Relation to Cash Flows"},"content":{"rendered":"<p><script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"Which discount rate would most appropriately discount cash flows to equity to estimate the value of equity for a firm?\",\n    \"answerCount\": 3,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is B. Rate of return on equity. Cash flows to equity (FCFE) should be discounted using the required rate of return on equity because these cash flows belong to equity holders. In contrast, the weighted average cost of capital (WACC) is used to discount cash flows to the firm (FCFF), while the rate of return on debt is used in evaluating debt-related cash flows.\"\n    },\n    \"suggestedAnswer\": [\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"Rate of return on debt.\"\n      },\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"Rate of return on equity.\"\n      },\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"Weighted average cost of capital.\"\n      }\n    ]\n  }\n}\n<\/script><\/p>\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/UnwokOxe4OM\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>When discounting cash flows analysts should use the discount rate that is consistent with the type of cash flow being discounted.<\/p>\n<p>A cash flow to equity should be discounted at the required rate of return on equity.<\/p>\n<p>When a cash flow is available to meet the claims of all of a company\u2019s capital providers, the firm\u2019s weighted average cost of capital is the appropriate discount rate.<\/p>\n<blockquote>\n<h2>Question<\/h2>\n<p>Which discount rate would <em>most appropriately<\/em> discount cash flows to equity to estimate the value of equity for a firm?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li>Rate of return on debt.<\/li>\n<li>Rate of return on equity.<\/li>\n<li>Weighted average cost of capital.<\/li>\n<\/ol>\n<h4>Solution<\/h4>\n<p><strong>The correct answer is B.<\/strong><\/p>\n<p>The rate of return on equity is the discount rate that would be used to discount cash flows to equity to estimate the value of equity of the firm.<\/p>\n<p><strong>A is incorrect. <\/strong>The rate of return on debt is used to estimate the amount of debt repayments that the firm makes on its debt.<\/p>\n<p><strong>C is incorrect. <\/strong>The weighted average cost of capital is used to discount cash flows to the firm to estimate the value of the entire firm.<\/p>\n<\/blockquote>\n<p>Reading 21: Return Concepts<\/p>\n<p><em>LOS 21 (h) Evaluate the appropriateness of using a particular rate of return as a discount rate, given a description of the cash flow to be discounted and other relevant facts.<\/em><\/p>\n<div style=\"text-align: center; margin: 30px 0;\"><a style=\"display: inline-flex; align-items: center; justify-content: center; padding: 12px 26px; border-radius: 9999px; background: #1e5bd8; color: #ffffff; font-weight: bold; text-decoration: none;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a> <\/p>\n<p style=\"margin-top: 12px; font-size: 16px; line-height: 1.5;\">Review how to select the appropriate discount rate for different cash flows with CFA Level 2 study notes, practice questions, mock exams, and video lessons designed to strengthen your exam preparation.<\/p>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>When discounting cash flows analysts should use the discount rate that is consistent with the type of cash flow being discounted. A cash flow to equity should be discounted at the required rate of return on equity. When a cash&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,401],"tags":[216,426,402,423],"class_list":["post-17195","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","tag-cfa-level-2","tag-discount-rate-selection-in-relation-to-cash-flows","tag-equity-valuation","tag-reading-25-return-concepts","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Discount Rate Selection &amp; Cash Flows | CFA L2<\/title>\n<meta name=\"description\" content=\"Learn how to select appropriate discount rates for cash flows, including WACC for all capital providers and equity discount rates for FCFE.\" \/>\n<meta name=\"robots\" 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