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. How do you calculate IRR in Excel?

    Understand how to calculate the internal rate of return (IRR) in Excel and how it's used to determine anticipated yield per ... Read Answer >>
  2. Which is a better measure for capital budgeting, IRR or NPV?

    All other things being equal, using IRR and NPV measurements to evaluate projects often results in the same findings. However, ... Read Answer >>
  3. What is the formula for calculating the internal rate of return (IRR)?

    Learn about the internal rate of return, an important concept in determining the relative attractiveness of different investments. Read Answer >>
  4. How do I use Excel to get discount rate over time?

    Learn how to calculate discount rate in Microsoft Excel and how to find the discount factor over a specified number of years. Read Answer >>
  5. How do you use discounted cash flow to calculate a capital budget?

    Learn how discounted cash flows are used in creating capital budgets as a part of the net present value and internal rate ... Read Answer >>
  6. What is the relationship between the hurdle rate (MARR) and the Internal Rate of ...

    Find out how companies and managers use hurdle rate, or MARR, and internal rate of return, or IRR, to evaluate projects and ... Read Answer >>
Related Articles
  1. Small Business

    Calculating the Internal Rate of Return Using Excel

    The internal rate of return on investments is explained and illustrated in different investment scenarios.
  2. Investing

    An Introduction To Capital Budgeting

    We look at three widely used valuation methods and figure out how companies justify spending.
  3. Investing

    Investors Need A Good WACC

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

    How to Compare Permanent Life Insurance Policies

    How you can use the internal rate of return to compare and purchase a permanent life insurance policy.
  5. Small Business

    Modified Internal Rate of Return (MIRR)

    Modified internal rate of return (MIRR) is a variant of the more traditional internal rate of return calculation.
  6. Small Business

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  7. Investing

    How to Calculate Required Rate of Return

    The required rate of return is used by investors and corporations to evaluate investments. Find out how to calculate it.
RELATED TERMS
  1. Internal Rate Of Return - IRR

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

    A measure for evaluating whether to proceed with a project or ...
  3. IRR

    The currency abbreviation or currency symbol for the Iranian ...
  4. The Net Internal Rate Of Return - Net IRR

    A measure of a portfolio or fund's performance that is equal ...
  5. Pooled Internal Rate Of Return - PIRR

    A method of calculating the overall internal rate of return (IRR) ...
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a ...
Hot Definitions
  1. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  2. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  3. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  4. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  5. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  6. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
Trading Center