Weighted average cost of capital (WACC) refers to minimum returns that an enterprise needs to make to fulfil all the stakeholders including preferred stockholders, bondholders and stockholders (Frank & Shen, 2016). Consequently, the internal rate of return (IRR) is the capital’s budgeting discount rate that makes the cash flows’ (both outflows and inflows) net present value (NPV) from a project to amount to zero. In this case, the Vestor Corporation IRR is expected to be 11.5% and based on WACC calculation, it is expected to be 9.10%. The WACC value of 9.10% was calculated using the capital asset pricing model (CAPM).
Generally, in a project, an IRR that is greater or equal to a company’s WACC should be accepted. However, when a project’s cost of capital is higher than its IRR, it should be rejected (Frank & Shen, 2016). In this case, the Vestor IRR is projected to be higher than the company’s WACC hence the warehouse investment will be beneficial to the company. Additionally, the calculation indicates that a 2.4% profit is expected to be made by Vestor Corporation.
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In conclusion, having the right calculations and information, there are many areas to focus on when determining the worthiness of an investment. Therefore, a company needs to consider all options to make a right decision. In this scenario, it would make sense to accept warehouse investment because its IRR is greater than its WACC and that a 2.4% profit is expected in the end.
Reference
Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics , 119 (2), 300-315.
