Question

Which of the following statements is CORRECT?

a.To implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital.
b. To implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the weighted average cost of capital.
c.To implement the corporate valuation model, we discount projected net income at the weighted average cost of capital.
d.To implement the corporate valuation model, we discount projected free cash flows at the cost of equity capital.
e. The corporate valuation model requires the assumption of a constant growth rate in all years.

Answer 1

a.To implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital.

Step-by-step explanation:

Common sense requires that like should be compared like, the free cash flows are meant for all providers of finance, debt, and equity stockholders alike, hence, in discounting the free cash flows to firm, the discount rate is the one that captures the overall cost of finance to the firm which is the weighted average cost of capital, hence, option "a" is correct.

Net income and NOPAT cannot be discounted since they are not cash flows

In the same vein,the free cash flows which are meant for debtholders and stockholders cannot be discounted at the cost of equity which is only an equity required rate of return