Which technique is often employed to determine the appropriate discount rate in DCF analysis?

The Capital Asset Pricing Model (CAPM) is a widely used technique for determining the appropriate discount rate in Discounted Cash Flow (DCF) analysis. This model quantifies the relationship between the expected return of an asset and its risk relative to the overall market.

CAPM calculates the expected return on an investment based on its systematic risk, represented by beta, which measures the asset's sensitivity to market movements. The formula incorporates the risk-free rate, typically derived from government bonds, and the equity market premium, which reflects the expected market return exceeding the risk-free rate. By using CAPM, analysts can derive a discount rate that accounts for both the time value of money and the investment's risk profile, making it a suitable choice for calculating the rate used in DCF analysis.

This discount rate is crucial as it ensures that future cash flows are adjusted for the risk associated with the investment, allowing for a more accurate present value calculation. While other models exist, such as WACC, DDM, and various risk-adjusted return models, they serve different contexts or are not as direct in assessing an equity discount rate as CAPM does.