What Is the Difference Between WACC and IRR?
Internal Rate of Return (IRR)
IRR is a valuation metric expressed as a percentage in which the net present value (NPV) of a stream of cash flows is equal to zero. The IRR equals the discount rate that yields an NPV of zero.
Commonly, the IRR is used by companies to analyze and decide on capital projects.
The higher the IRR the better the expected financial performance of the project and higher expected return to the company.
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Weighted Average Cost of Capital (WACC)
WACC is the average after-tax cost of a company’s capital sources expressed as a percentage. It measures the cost a company pays out for its debt and equity financing. It is better for the company when the WACC is lower, as it minimizes its financing costs. The WACC varies due to leverage and the company’s perceived risk relative to its peers.
IRR & WACC
Companies need the IRR to be greater than the WACC in order to cover the financing cost of the investment.
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.
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.
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