WACC is applied on which basis in a DCF?

WACC is applied on which basis in a DCF?

• A. Levered
• B. Unlevered
• C. Before financing decisions
• D. On an unlevered basis

Answer: (D)

When valuing a firm with a DCF, you discount unlevered cash flows—cash flows generated before any financing decisions. WACC represents the blended return required by both debt and equity holders for the firm’s assets, so it’s the appropriate discount rate for those unlevered cash flows (free cash flow to the firm). If you used levered cash flows (to equity) you’d instead apply the cost of equity. So, WACC is applied on an unlevered basis.

When valuing a firm with a DCF, you discount unlevered cash flows—cash flows generated before any financing decisions. WACC represents the blended return required by both debt and equity holders for the firm’s assets, so it’s the appropriate discount rate for those unlevered cash flows (free cash flow to the firm). If you used levered cash flows (to equity) you’d instead apply the cost of equity. So, WACC is applied on an unlevered basis.