In a discounted cash flow valuation, what discount rate is typically used?

• A. Prime rate
• B. WACC
• C. Inflation rate
• D. Market risk premium only

Answer: (B)

Discounting in a DCF reflects the risk-adjusted opportunity cost of the capital used to fund the project or firm. For valuing an entire firm using free cash flow to the firm, the appropriate rate is the Weighted Average Cost of Capital, because it blends the costs of equity and debt in proportion to their use and matches the risk of the firm’s overall cash flows. The other options don’t fit because the inflation rate is about price changes, not the required return; the prime rate is a short-term lending rate and doesn’t reflect project risk; and using only the market risk premium ignores the time value of money and the cost of debt. If valuing just equity cash flows, you’d use the cost of equity, but for standard firm valuation with FCFF, WACC is typical.