Which statement best describes IRR vs WACC in project evaluation?

Which statement best describes IRR vs WACC in project evaluation?

• A. IRR is the rate that makes NPV zero; WACC is the company's average cost of capital used as a discount rate.
• B. IRR is the rate that makes NPV zero; WACC is the company's average cost of capital used for discounting cash flows.
• C. IRR is used to measure project profitability; WACC is used to determine the tax rate.
• D. IRR is used to evaluate financing decisions; WACC is used for budgeting.

Answer: (B)

The key idea is how IRR and WACC fit into project evaluation. The internal rate of return is the rate that makes the project’s net present value equal to zero—it’s the break-even return the project would earn on its cash flows if you could reinvest at that same rate. WACC, the weighted average cost of capital, is the company's overall cost of financing its operations, reflecting debt and equity costs and their relative weights. In evaluating projects using NPV, WACC is used as the discount rate to bring future cash flows to present value. So the best description is the one that states IRR is the rate that makes NPV zero and WACC is the company’s average cost of capital used for discounting cash flows. That captures the precise roles: IRR is a rate derived from the project’s cash flows; WACC is the hurdle rate used to discount those cash flows.

The key idea is how IRR and WACC fit into project evaluation. The internal rate of return is the rate that makes the project’s net present value equal to zero—it’s the break-even return the project would earn on its cash flows if you could reinvest at that same rate. WACC, the weighted average cost of capital, is the company's overall cost of financing its operations, reflecting debt and equity costs and their relative weights. In evaluating projects using NPV, WACC is used as the discount rate to bring future cash flows to present value.

So the best description is the one that states IRR is the rate that makes NPV zero and WACC is the company’s average cost of capital used for discounting cash flows. That captures the precise roles: IRR is a rate derived from the project’s cash flows; WACC is the hurdle rate used to discount those cash flows.