If a firm's IRR is below the cost of capital, what does this generally indicate?

When a firm's Internal Rate of Return (IRR) is below the cost of capital, it signifies that the project's expected return is not sufficient to meet the cost of financing the investment. The cost of capital represents the minimum return that investors require to compensate for the risk of the investment.

If the IRR is below this threshold, it indicates that the project is likely to generate returns that are less than what investors could achieve elsewhere with similar risk profiles. Consequently, the project may not add value to the firm, as it would lead to a decline in shareholder wealth if pursued. Firms generally seek projects where the IRR exceeds the cost of capital, as this would suggest that they are creating value for their shareholders.

In contrast, if the IRR is higher than the cost of capital, it would suggest that the project could be a worthwhile investment. Therefore, the conclusion that the project may not add value is directly tied to the relationship between IRR and the cost of capital.