A company should choose those capital investment processes that maximize shareholder wealth.

The

According to the NPV rule, a company should accept projects where the NPV is positive and reject those in which the NPV is negative. A positive NPV suggests that cash inflows outweigh cash outflows on a present value basis. That is, the positive cash flows are sufficient to repay the initial investment along with the capital costs (opportunity cost) associated with the project. If the company must choose between two, mutually-exclusive projects, the one with the higher NPV should be chosen.

According to the IRR Rule, a company should accept projects where the IRR is greater than the discount rate used (WACC) and reject those in which the IRR is less than the discount rate. An IRR greater than the WACC suggests that the project will more than repay the capital costs (opportunity costs) incurred.

There are three problems associated with IRR as a decision rule.

**Reinvestment****Scale****Timing**

achu: RTS probs of irr : reinvestment, scalability,, timing. |

vibs: what is WACC? |

ribkanemo: weighted average cost of capital (WACC) |

aras: WACC says everything about the capital structure of a project or a company. It is the average debt + equity used by a company. It is mostly used as a discount rate when undertaking a DCF analysis to calculate the NPV. |

StanleyMo: nice explain aras, |

studyprep: also note that it is 'weighted' average. because cost of borrowing and cost of selling equity are different for the same company. |

TiredHand: To explain WACC, if for example you were working with a project that was 70% debt funded and 30% equity funded, and the debt interest rate (post tax) is 8% and the cost of the equity is 5% then the WACC = (0.7 x 8%) + (0.3 x 5%) = hold on that doesn't work. Ignore me |

meeruka: can somebody explian reinvestment problem.iam unclear with description |

sunnyhui: reinvestment problem - irr assume the same interest rate for investment it same for all cashflow and at same time, but if cashflow is at different times then interest rate is different hmm IRR can be inaccurate estimate at times |

chesschh: we still have to learn how to calculate npv and irr |

dweik: WACC takes the weighted average cost of the capital used to fund the project.Let's say a company uses 50% debt and 50% equity. The debt costs 5% and the equity costs 6%. The WACC will be (5 * 0.5) + (6 * 0.5) which will give a WACC of 5.5% Calculating the components of the WACC is a different story all together though. |

012905nv: Thank you for the comments on WACC, it is very helpful!! |

khalifa92: ignore this reading because ull go through this all in corporate finance with a better understanding and more exhaustive information (use textbook). |