Or Weighted Average Cost of Capital

A calculation of a company's cost of capital in which every source of capital is weighted in proportion to how much capital it contributes to the company. For example, if 75% of a company's capital comes from stock and 25% comes from debt, measuring the cost of capital weights these accordingly. A high WACC indicates that a company is spending a comparatively large amount of money in order to raise capital, which means that the company may be risky. On the other hand, a low WACC indicates that the company acquires capital cheaply. WACC Limitations Does not take account of risk Stability of capital structure WACC is not easy to obtain because of the different types of data that have to be found. It is a complicated measure that requires a lot of detailed company information Most businesses use WACC and recalculate it at least annually Advantages Calculating equity value using WACC takes into account the market capitalization plus the debt plus the cost of financing that debt. Payback period: The length of time required to recover the cost of an investment. Calculated as:

Advantages of Payback Period Considers the time value of money Considers the riskiness of the project's cash flows (through the cost of capital) Disadvantages No concrete decision criteria that indicate whether the investment increases the firm's value Requires an estimate of the cost of capital in order to calculate the payback Ignores cash flows beyond the discounted payback period

Average Rate of Return (ARR):

The average rate of return expresses the profits arising from a project as a percentage of the initial capital cost. However the definition of profits and capital cost are different depending on which textbook you use. For instance, the profits may be taken to include depreciation, or they may not. One of the most common approaches is as follows: ARR = (Average annual revenue / Initial capital costs) * 100 Let's use this simple example to illustrate the ARR: A project to replace an item of machinery is being appraised. The machine will cost 240 000 and is expected to generate total revenues of 45 000 over the project's five year life. What is the ARR for this project? ARR = (45 000 / 5) / 240 000 * 100 = (9 000) / 240 000 * 100 = 3.75% Advantages of ARR As with the Payback method, the chief advantage with ARR is its simplicity. This makes it relatively easy to understand. There is also a link with some accounting measures that are commonly used. The Average Rate of Return is similar to the Return on Capital Employed in its construction; this may make the ARR easier for business planners to understand. The ARR is expressed in percentage terms and this, again, may make it easier for managers to use. There are several criticisms of ARR which raise questions about its practical application:

Disadvantages of ARR: Firstly, the ARR doesn't take account of the project duration or the timing of cash flows over the course of the project. Secondly, the concept of profit can be very subjective, varying with specific accounting practice and the capitalisation of project costs. As a result, the ARR calculation for identical projects would be likely to result in different outcomes from business to business. Thirdly, there is no definitive signal given by the ARR to help managers decide whether or not to invest. This lack of a guide for decision making means that investment decisions remain subjective.

What are the advantages and disadvantages associated with Net present value and internal rate of return?
Answer
Well NPV says about the value remain with you today by taking an investment decision of say n years.it gives the value in terms of RS. or $. where as IRR says only in terms of percentage. The advantage of NPV is that is increases the wealth of the share holders.as it gives you money. Where as IRR is indicating a rate of return of a project. with the help of IRR one can find the discount rate at which the total amout received on the investment is equal to the investment that is made today.one would be at no risk of loosing the money as the required rate of return should be equal to or higher then the IRR. NPV only gives an indication of the value of the money today but nobody knows the exect Rate of Return OF a project so IRR gives you the RATE at which you are safe.where in NPV a discount rate is assumeed. reguards Anant Pattjoshi MBA(Finance) Cosmic Business School New Delhi-44 Net Present Value Advantages Tells whether the investment will increase the firm's value Considers all the cash flows Considers the time value of money Considers the risk of future cash flows (through the cost of capital) Disadvantages Requires an estimate of the cost of capital in order to calculate the net present value Expressed in terms of dollars, not as a percentage Internal Rate of Return Advantages Tells whether an investment increases the firm's value Considers all cash flows of the project Considers the time value of money Considers the risk of future cash flows (through the cost of capital in the decision rule) Disadvantages Requires an estimate of the cost of capital in order to make a decision May not give the value-maximizing decision when used to compare mutually exclusive projects May not give the value-maximizing decision when used to choose projects when there is capital rationing Cannot be used in situations in which the sign of the cash flows of a project change more than once during the project's life

WACC - Weighted Average Cost of Capital Corporations create value for shareholders by earning a return on the invested capital that is above the cost of that capital. WACC (Weighted Average Cost of Capital) is an expression of this cost and is used to see if certain intended investments or strategies or projects or purchases are worthwhile to undertake.

WACC is expressed as a percentage, like interest. So for example if a company works with a WACC of 12%, than this means that only (and all) investments should be made that give a return higher than the WACC of 12%. The cost of capital for any investment, whether for an entire company or for a project, is the rate of return capital providers would expect to receive if they would invest their capital elsewhere. In other words, the cost of capital is an opportunity cost.

Or Weighted average cost of capital

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Companies raise money from a number of sources: common equity, preferred equity, straight debt, convertible debt, exchangeable debt, warrants, options, pension liabilities, executive stock options, governmental subsidies, and so on. Different securities are expected to generate different returns. The WACC is calculated taking into account the relative weights of each component of the capital structure and is used to see if the investment is worthwhile to undertake. The more complex the company's capital structure, the more laborious it is to calculate the WACC.

Net Present Value The Net Present Value (NPV) of a project or investment is defined as the sum of the present values of the annual cash flows minus the initial investment. The annual cash flows are the Net Benefits (revenues minus costs) generated from the investment during its lifetime. These cash flows are discounted or adjusted by incorporating the uncertainty and time value of money. NPV is one of the most robust financial evaluation tools to estimate the value of an investment.