Final answer:
The appropriate discount rate to use in discounting a firm's free cash flow depends on factors such as the riskiness of the investment, the firm's cost of capital, and the opportunity cost of investing in alternative projects. The discount rate is typically the firm's weighted average cost of capital (WACC), which represents the average return expected by investors for providing capital to the firm.
Step-by-step explanation:
The appropriate discount rate to use in discounting a firm's free cash flow depends on various factors such as the riskiness of the investment, the firm's cost of capital, and the opportunity cost of investing in alternative projects. The discount rate is typically the firm's weighted average cost of capital (WACC), which represents the average return expected by investors for providing capital to the firm. The WACC takes into account the cost of debt and the cost of equity, weighted by their respective proportions in the firm's capital structure.
For example, if a firm's WACC is 10%, then the appropriate discount rate to use in discounting its free cash flow would be 10%. This means that the firm is assuming an opportunity cost of 10% by investing in the project.
It's important to note that the appropriate discount rate may vary depending on the specific circumstances and risk profile of the firm and the investment being evaluated.