IRR decreases while MCC increases
Why Does IRR decrease while MCC increases ?
1 answers ( 0 marked as helpful)
Hello Laith,
Thanks for reaching out!
IRR and MCC move in opposite directions because they measure different things and are affected by different forces as investment size grows.
1. IRR decreases as projects get larger or less attractive
When a firm invests in projects, it usually starts with the most profitable opportunities first. These projects have high expected returns, so their IRRs are high.
As the firm takes on additional projects, it often has to accept opportunities with lower expected returns, causing the IRR of marginal projects to decline.
2. MCC increases as more capital is raised
The Marginal Cost of Capital reflects how much it costs to raise the next unit of financing. As a firm raises more capital:
Cheaper sources of financing (like retained earnings or low-cost debt) get exhausted
The firm may need to issue new equity or higher-interest debt Investors demand higher returns due to increased risk As a result, the MCC curve slopes upward.
Hope this helps!
Best,
The 356 Team
Thanks for reaching out!
IRR and MCC move in opposite directions because they measure different things and are affected by different forces as investment size grows.
1. IRR decreases as projects get larger or less attractive
When a firm invests in projects, it usually starts with the most profitable opportunities first. These projects have high expected returns, so their IRRs are high.
As the firm takes on additional projects, it often has to accept opportunities with lower expected returns, causing the IRR of marginal projects to decline.
2. MCC increases as more capital is raised
The Marginal Cost of Capital reflects how much it costs to raise the next unit of financing. As a firm raises more capital:
Cheaper sources of financing (like retained earnings or low-cost debt) get exhausted
The firm may need to issue new equity or higher-interest debt Investors demand higher returns due to increased risk As a result, the MCC curve slopes upward.
Hope this helps!
Best,
The 356 Team