{"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":"2022-09-08T10:25:37","modified_gmt":"2022-09-08T10:25:37","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><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","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 v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Discount Rate Selection in Relation to Cash Flows - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"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.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/discount-rate-selection-in-relation-to-cash-flows\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Discount Rate Selection in Relation to Cash Flows - 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