What discount rate should be used in a DCF analysis?

In a Discounted Cash Flow (DCF) analysis, the discount rate used is critical because it reflects the opportunity cost of investing in the asset and adjusts for the risk associated with the cash flows being evaluated. The cost of capital for the business being valued accurately incorporates the weighted average cost of equity and debt financing. This rate accounts for the risk profile of the company-specific operational and financial structure, indicating the returns that investors expect for bearing that risk.

By using the cost of capital, the analysis appropriately factors in both the time value of money and the risks related to the particular business, enabling a more accurate assessment of the present value of its expected future cash flows. This choice ensures the discount rate is tailored to the specific context of the business rather than relying on general market figures or less relevant benchmarks.

In contrast, other options do not provide the necessary specificity or relevance to the business being valued, failing to capture the required risk adjustments for a precise evaluation.