In which analysis is the Cost of Equity used for discounting cash flows?

The Cost of Equity is used for discounting cash flows in a Levered DCF analysis because this method specifically evaluates the present value of future free cash flows available to equity holders after accounting for interest payments on debt. In a Levered DCF, the focus is on the cash flows that accrue to equity shareholders, meaning that the discount rate applied should reflect the cost to those equity investors.

The Cost of Equity accounts for the risk perceived by shareholders and includes elements such as market risk and expected return on equity investments. It is derived from models like the Capital Asset Pricing Model (CAPM), which incorporates the risk-free rate and the equity risk premium. Therefore, using this rate as the discount factor in a Levered DCF accurately captures the required return on equity investments, aligning it with the expectations of equity holders concerning potential returns on their investment.

Meanwhile, the other types of analyses mentioned – Unlevered DCF and Comprehensive DCF – involve different approaches and considerations in terms of cash flows and capital structure. In an Unlevered DCF approach, cash flows before debt payments are discounted using the Weighted Average Cost of Capital (WACC), which incorporates both the cost of equity and the cost of debt for the overall firm view, rather than