question archive Suppose that your company's weighted-average cost of capital is 9 percent
Suppose that your company's weighted-average cost of capital is 9 percent
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Suppose that your company's weighted-average cost of capital is 9 percent. Your company is planning to undertake a project with an internal rate of return of 12%, but you believe that this project is not a good investment for the firm. What logical arguments might you use to convince your boss to forego the project despite its high rate of return? Is it possible that making investments with expected returns higher than your company's cost of capital will destroy value? If so, how?
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Answer:
Yes, since the IRR (12%) is higher than its WACC (9%). On the basis of IRR we can't select the project, because it may mislead in some times, especially in mutually exclusive projects, and non-conventional cash flows of the project. In our case the IRR is showing 12%, but whether it is satisfying the NPV equals to make zero or not we don't know. As the reason we can't simply select the project if it's IRR might be higher than its WACC. For any project selection, IRR is a metric used in financial analysis to estimate the profitability of potential investments as it rely on the same formula as NPV does.
