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 measures can be used to evaluate the capital adequacy of a bank?

    Examine some of the different financial measurements that are most commonly used to assess capital adequacy within the banking ...
  3. What are some examples of a deferred tax liability?

    Learn why deferred tax liability exists, with specific examples that illustrate how it arises as a result of temporary differences.
  4. What dividend yield is typical for companies in the industrial sector?

    Find out more about dividend yields, what the dividend yield measures and what level of dividend yield is typical for companies ...
RELATED TERMS
  1. IRR Rule

    A measure for evaluating whether to proceed with a project or ...
  2. Internal Rate Of Return - IRR

    The discount rate often used in capital budgeting that makes ...
  3. Weighted Average Cost Of Capital - WACC

    A calculation of a firm's cost of capital in which each category ...
  4. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative ...
  5. Nonadmitted Balance

    An item on an insurer’s balance sheet that represents reinsured ...
  6. Best's Capital Adequacy Relativity (BCAR)

    A rating of an insurance company’s balance sheet strength. Best’s ...

You May Also Like

Related Articles
  1. Investing

    Weighted Average Cost Of Capital (WACC)

  2. Term

    IRR Rule

  3. Budgeting

    Which is a better measure for capital ...

  4. Term

    Internal Rate Of Return - IRR

  5. Term

    Weighted Average Cost Of Capital - WACC

Trading Center