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 ... Read Full Answer >>
  2. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  3. What is the formula for calculating weighted average cost of capital (WACC) in Excel?

    When analyzing different financing options, companies need to look at how much it will cost to fund operations. There are ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
Related Articles
  1. Investing

    Weighted Average Cost Of Capital (WACC)

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality
  2. Investing

    How To Calculate Minority Interest

    Minority interest calculations require the use of minority shareholders’ percentage ownership of a subsidiary, after controlling interest is acquired.
  3. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
  5. Technical Indicators

    Key Financial Ratios to Analyze the Mining Industry

    Discover some the most important financial ratios used by investors and analysts to evaluate companies in the metals and mining industry.
  6. Technical Indicators

    Key Financial Ratios to Analyze Retail Banks

    Learn about key financial metrics that investors use to evaluate retail banks, and how the industry is fundamentally different from most other industries.
  7. Technical Indicators

    Key Financial Ratios to Analyze Airline Companies

    Examine some of the most important financial ratios and performance metrics investors use to evaluate companies in the airline industry.
  8. Stock Analysis

    The 5 Biggest Canadian Oil Companies

    Obtain information about some of the largest and most successful major integrated oil corporations that are headquartered in Canada.
  9. Technical Indicators

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  10. Stock Analysis

    3 Reasons to Continue to Own Monster Beverage

    Learn more about the Monster Beverage Corporation and some of the primary reasons why investors and market analysts like the stock.
RELATED TERMS
  1. Weighted Average Cost Of Capital - WACC

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

    A metric used in capital budgeting measuring the profitability ...
  3. IRR Rule

    A measure for evaluating whether to proceed with a project or ...
  4. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  6. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!