The internal rate of return is a rate considered by firms when they are making investments. It makes all cash flows into a capital project equal zero (so balance out). The IRR indicates how much value a firm will receive from making a particular investment - so could be thought of as the estimated return. Capital, on the other hand, is the value of the investment necessary for a particular project. For an investment to be worthwhile, the internal rate of return must outweigh the cost of capital input. Therefore it is possible that a change in the cost of capital could deter a firm from making an investment. Of course, if capital became cheaper, this would incentivize firms to invest - providing the capital is smaller than the IRR.
It should be noted that the cost of capital and the internal rate of return do not directly affect one another. Rather, they are two factors that are compared by companies considering an investment. The higher the internal rate of return is, and the cheaper capital is, the more a firm will be incentivized to undertake an investment project. It is impossible to know the exact internal rate of return for an investment - any value used is an estimate.
The bigger (positive) difference is between the internal rate of return and the cost of capital, the more profit a company could make. Therefore firms look to maximize their IRR value and minimize the cost of capital. They will monitor changes in the cost of capital carefully, to ensure it doesn’t rise rapidly. If the project is long term, a firm may need to consider the possibility of future changes in the cost of capital, which may involve considering the current economic climate.
It should be noted that the cost of capital and the internal rate of return do not directly affect one another. Rather, they are two factors that are compared by companies considering an investment. The higher the internal rate of return is, and the cheaper capital is, the more a firm will be incentivized to undertake an investment project. It is impossible to know the exact internal rate of return for an investment - any value used is an estimate.
The bigger (positive) difference is between the internal rate of return and the cost of capital, the more profit a company could make. Therefore firms look to maximize their IRR value and minimize the cost of capital. They will monitor changes in the cost of capital carefully, to ensure it doesn’t rise rapidly. If the project is long term, a firm may need to consider the possibility of future changes in the cost of capital, which may involve considering the current economic climate.
