IRR vs RRR vs WACC
What is the difference between IRR, WACC and RRR?
By Jeff Robson
IRR is the internal rate of return. RRR is the required rate of return.
The IRR is simply the discount rate, which, when applied to a series of cashflows, gives a net present value (NPV) of zero.
i.e. NPV(IRR, [cashflows]) = 0
Normally there’s just one IRR however, in some instances, there’s no IRR, sometimes there are two IRR’s (more on this in another article).
The RRR (or hurdle rate) is the return a company requires on its projects in order to proceed with them. This is a fairly arbitrary number and differs from company to company. It is not necessarily related to the cost of funds.
Put another way, if NPV(RRR, [cashflows]) > 0 for a given project then that project passes the required rate of return (RRR) test and may be evaluated further.
If NPV(RRR, [cashflows]) < 0 the project could still be a great project and generate value for shareholders, but it doesn’t pass the company’s required rate of return test.
The Weighted Average Cost of Capital (WACC) represents the average cost of funds for a company. Companies must get capital from investors and/or debt providers.
Both have many options as to where they will invest/lend their funds and as such, they weigh up the risks and potential returns offered by a company.
As a result, companies must offer to pay a rate of return (dividend or interest) commensurate with the risk borne by investors or debt providers.
If NPV(WACC, [cashflows]) > 0 then the project generates returns that exceed the company’s cost of capital i.e. the project generates value. The opposite is also true.
Normally: WACC < RRR
The IRR can take any value.