IRR vs WACC

1 Cuong Nguyen – 02133524 BUS 212 David Plisco May 12, 2015 Diference between WACC and IRR

Inves!en analysis and cos o" ca#ial a$e %o o" &e !os i!#o$an as#ecs o" 'nancial !anage!en( )e &ave !y inves!en analysis ools and ec&ni*ues &a a$e used o evaluae &e #$o'a+iliy and "easi+iliy o" a #$oec( Cos o" ca#ial ai!s o e-#lo$e &e va$ious sou$ces o" ca#ial and &o% coss a$e calculaed( I.s also used oge&e$ %i& inves!en a##$aisal ec&ni*ues ec&ni*ues o co!e u# %i& &e via+iliy o" #$oecs( /e.s aes a close$ loo a I ine$nal $ae o" $eu$n and &e conce# o" %eig&ed ave$age cos o" ca#ial )CC, and %&en o use &e! a##$o#$iaely( I, so!ei!es $e"e$$ed o as econo!ic $ae o" $eu$n 6, is a 'nancial analysis ool &a.s used !ainly o dee$!ine &e a$aciveness o" a #a$icula$ #$oec o$ inves!en( I.s also used o c&oose +e%een #ossi+le #$oecs o$ inves!en o##o$uniies o##o$uniies &a a$e +eing conside$ed( I is !osly used in ca#ial +udgeing and !aes &e NP7 ne #$esen value o" all cas& 8o%s "$o! a #$oec o$ inves!en e*ual o 9e$o( In o&e$ %o$ds, I is &e $ae o" g$o%& &a an inves!en is esi!aed o gene$ae( I is $ue &a an inves!en !ig& acually gene$ae a $ae o" $eu$n &a is di:e$en o &e esi!aed I( )&en an inves!en %i& a $elaively &ig&e$ I, i.s !o$e liely %ould end u# %i& &ig&e$ $eu$ns and s$onge$ g$o%&( In insances in %&ic& &e I is used o !ae a decision +e%een acce#ing and $eecing a #$oec, &e "ollo%ing c$ie$ia !us +e "ollo%ed( I" &e I is e*ual o o$ g$eae$ &an &e cos o" ca#ial &e #$oec s&ould +e acce#ed and i" &e I is less &an &e cos o" ca#ial &e #$oec s&ould +e $eeced( ;&ese c$ie$ia %ill ensu$e &a &e '$! ea$ns a leas is $e*ui$ed $eu$n( )&en deciding +e%een

2 %o #$oecs &a &ave di:e$en I nu!+e$s i is +es o #ic &e #$oec &a &as &e &ig&es I( I can also +e used o co!#a$e +e%een $aes o" $eu$n in 'nancial !a$es( I" &e '$!.s #$oecs do no gene$ae an I &ig&e$ &an &e $ae o" $eu$n &a can +e o+ained +y invesing in &e 'nancial !a$es, i is !o$e #$o'a+le "o$ &e '$! o $eec &e #$oec and !ae an inves!en in &e 'nancial !a$e "o$ a +ee$ $eu$n(  ;&e "o$!ula I can +e ve$y co!#le- de#ending on &e i!ing and va$iances in cas& 8o% a!ouns(
&e !a$e value o" e*uiy and

o" 6 and D(

D is

&e !a$e value o" de+ and

V is

&e oal

3 Re is

&e oal cos o" e*uiy and

Rd is

&e cos o" de+(

T is

&e a- $ae a##lied o

&e co!#any(

 co!#any>s asses a$e 'nanced +y ei&e$ de+ o$ e*uiy( )CC is &e ave$age o" &e coss o" &ese sou$ces o" 'nancing, eac& o" %&ic& is %eig&ed +y is $es#ecive use in &e given siuaion( By aing a %eig&ed ave$age, %e can see &o% !uc& ine$es &e co!#any &as o #ay "o$ eve$y dolla$ i 'nances(

 '$!>s )CC is o"en used ine$nally +y co!#any di$eco$s o dee$!ine &e econo!ic "easi+iliy o" e-#ansiona$y o##o$uniies and !e$ge$s( I is &e a##$o#$iae discoun $ae o use "o$ cas& 8o%s %i& $is &a is si!ila$ o &a o" &e ove$all '$!

)&en do %e use %&ic&? )CC is &e e-#eced ave$age "uu$e cos o" "unds, %&e$eas I is an inves!en analysis ec&ni*ue &a is used o decide %&e&e$ a #$oec s&ould +e "ollo%ed &$oug&( no&e$ use o" I is in &e co!#uaion o" #o$"olio, !uual "und o$ individual soc $eu$ns( In !os cases, &e adve$ised $eu$n %ill include &e assu!#ion &a any cas& dividends a$e $einvesed in &e #o$"olio o$ soc( ;&e$e"o$e, i is i!#o$an o sc$uini9e &e assu!#ions %&en co!#a$ing $eu$ns o" va$ious inves!ens( ;&e$e is a close $elaions&i# +e%een I and )CC as &ese conce#s oge&e$ !ae u# &e decision c$ie$ia "o$ I calculaions( I" &e I is g$eae$ &an )CC, &en &e #$oec.s $ae o" $eu$n is g$eae$ &an &e cos o" &e ca#ial &a %as invesed and s&ould +e acce#ed( Secu$iies analyss e!#loy )CC all &e i!e %&en valuing and selecing inves!ens( In discouned cas& 8o% analysis, "o$ insance, )CC is used as &e

4 discoun $ae a##lied o "uu$e cas& 8o%s "o$ de$iving a +usiness>s ne #$esen value( I also #lays a ey $ole in econo!ic value added 67 calculaions( Inveso$s use )CC as a ool o decide %&e&e$ o inves( ;&e )CC $e#$esens &e !ini!u! $ae o" $eu$n a %&ic& a co!#any #$oduces value "o$ is inveso$s( By con$as, i" &e co!#any>s $eu$n is less &an )CC, &e co!#any is s&edding value, %&ic& indicaes &a inveso$s s&ould #u &ei$ !oney else%&e$e( )CC se$ves as a use"ul $ealiy c&ec "o$ inveso$s, and &ey s&ould no% &e !eaning o" )CC %&en &ey see i in +$oe$age analyss> $e#o$s(