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 is common stock and preferred stock?

    Learn about the differences between common and preferred shares. Explore situations where preferred shares have more favorable ...
  3. What is the difference between a fixed asset and a current asset?

    Discover the difference between fixed assets and current assets and the value of each to a company. Learn the category and ...
  4. Why should fundamental investors pay attention to Cash Value Added (CVA)?

    Take a deeper look at cash value added, a metric used by fundamental investors to assess the ability of a company to meet ...
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. 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 ...

You May Also Like

Related Articles
  1. Investing

    What Happened To Obama’s Amnesty Bill?

  2. Charts & Patterns

    The Future of Qualcomm's Stock

  3. Fundamental Analysis

    Earnings Quality, the Facebook Example

  4. Trading Strategies

    Novice Trading Strategies

  5. Trading Strategies

    Not All Online Trading Brokers Are Created ...

Trading Center