What's the difference between weighted average cost of capital (WACC) and internal rate of return (IRR)?

By Jean Folger AAA
A:

Weighted average cost of capital (WACC) is the average after-tax cost of a company’s various capital sources, including common stock, preferred stock, bonds and any other long-term debt. By taking the weighted average, the WACC shows how much interest the company pays for every dollar it finances.

The internal rate of return (IRR), on the other hand, is the discount rate used in capital budgeting that makes the net present value (NPV) of all cash flows (both inflow and outflow) from a particular project equal to zero. It is used by companies to compare and decide between capital projects. For example, a company may evaluate an investment in a new plant versus expanding an existing plant based on the IRR of each project.

The primary difference between WACC and IRR is that where WACC is the expected average future costs of funds (from both debt and equity sources), IRR is an investment analysis technique used by companies to decide if a project should be undertaken. A close relationship exists between WACC and IRR, however, because together these concepts make up the decision for IRR calculations. In general, the IRR method indicates that a project whose IRR is greater than or equal to the firm's cost of capital should be accepted, and a project whose IRR is less than the firm's cost of capital should be rejected. 

RELATED FAQS

  1. Which is a better measure for capital budgeting, IRR or NPV?

    In capital budgeting, there are a number of different approaches that can be used to evaluate any given project, and each ...
  2. What are the main components of the Federal Reserve's balance sheet?

    Find out which items are listed as assets and liabilities on the balance sheet of the Federal Reserve, and how to read the ...
  3. What's more important, cash flow or profits?

    Learn about the different effects that cash flow and profit have on a business so you can decide which aspect to focus on.
  4. Which leverage ratios are most useful for analyzing manufacturing companies?

    See which leverage ratios investors and creditors are likely to use when analyzing the debt burdens for manufacturing companies.
RELATED TERMS
  1. IRR Rule

    A measure for evaluating whether to proceed with a project or ...
  2. Weighted Average Cost Of Capital - WACC

    A calculation of a firm's cost of capital in which each category ...
  3. Internal Rate Of Return - IRR

    The discount rate often used in capital budgeting that makes ...
  4. Best's Capital Adequacy Relativity (BCAR)

    A rating of an insurance company’s balance sheet strength. Best’s ...
  5. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
  6. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
Related Articles
  1. SIC Vs. NAIC -An Introduction To Industry ...
    Fundamental Analysis

    SIC Vs. NAIC -An Introduction To Industry ...

  2. Investing In New York City REITs
    Mutual Funds & ETFs

    Investing In New York City REITs

  3. The Big Credit Card Companies Have Room ...
    Stock Analysis

    The Big Credit Card Companies Have Room ...

  4. Why Wall Street Is A Key Player In The ...
    Investing Basics

    Why Wall Street Is A Key Player In The ...

  5. Penny Stocks, Options and Trading on ...
    Options & Futures

    Penny Stocks, Options and Trading on ...

Trading Center