Discount Rate - Calculation & Formula for NPV (Hindi) - YouTube

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Namaskar, my name is Mukul and welcome to Asset Yogi.

Where we unlock the knowledge of Finance.

In this video, we are going to discuss a very important topic today.

It is Discount Rate.

I made a lot of videos earlier about Project Evaluation Techniques.

Then we made videos about Time Value of Money.

Like if you want to invest money in some project or invest in any business,

Or want to evaluate an investment.

So you can calculate NPV and calculate IRR.

can calculate Payback period.

Profitability Index can be calculated.

There is a common factor under all these techniques which we call the Discount rate.

Now what should be this Discount rate?

what is this exactly?

About this we will go into a little detail in this video.

Because it depends on the Discount rate

whether your project will be Viable or Non-viable.

So it is very important to get the right Discount rate.

So how much should we take this discount rate,

that is what we will discuss in this video.

So you must watch this video till the last,

Let's go straight to the black board.

So let us understand the Discount rate by example.

I am taking the same example that we took in NPV and IRR videos.

There is a Car renting company that is evaluating whether to start a new route or not.

And whichever route they start whether it will give them their expected returns.

Now let's assume the Car they are buying to drive on the new route.

Let's say its price is 10 lakh rupees.

So I have plotted the cash flows of this vehicle here.

5 years cash flows are plotted.

So now in today's date, which we consider as zero date,

then your ₹ 10 lakhs has been invested here.

So it's in negative, I'll put it here in brackets.

And I have written this at the bottom of the timeline in negative.

So, 10 lakh rupees is Invested on zero date.

The Net cash flows that you make in the first year,

after taking out all the expenses,

you earn 1.5 lakh rupees from this vehicle in the first year.

In the second year, your net cash flows are 2 lakh, 3 lakh in the third year,

In the fourth year, the car is old, so it's 2.5 lakh rupees.

In the fifth year if you sell that car for ₹ 4 lakhs

So, it becomes Terminal Cash flow

that here you sold that car or whatever you are investing in a project,

you sold that project, so how much money can you get?

Or you sold the Asset of that business or project,

So, how much money can you get?

we call it Terminal cash flow.

So, in this case, you get ₹ 4 lakh by selling the car.

And ₹ 2 lakh you get from the cash flow of the operations.

So from the cash flow of the operation you earned 2.5 lakh,

then even here you have earned 2 lakh rupees.

So, it becomes 2+4 i.e. 6 lakh net cash flow in the fifth year.

What will you do then, you need to find out a net present value,

and for that Net Present value you need Discount rate.

So what is the discount rate basically?

you will bring this money in present value,

then after 1 year you are getting 1.5 lakhs.

What will be its present value today?

I'll call it P1.

In the same way, you will take out P2 of the second year also.

you find of the third year as well as on zero date.

And also of fourth and fifth year.

So when you will all the present values and you will subtract ₹ 10 lakh from it.

We call it Net Present Value.

And for the net present value, you need a discount rate.

Discount rate means when you bring this value of 1.5 lakhs to the present value.

So you need a rate of return.

by what percent you will discount it.

If you have not seen my videos of Present value or

the Time value of money, then definitely watch those videos.

in that we need a discount rate.

Like if you invest some money at an interest rate on today's date.

So in future it may become 1.5 lakh

it means this, on how much money you invest? how much money you must invest?

That it becomes 1.5 lakh rupees at a particular interest rate after 1 year.

So that percentage is what we call the discount rate.

So how do you calculate the discount rate?

This could be your expected rate of return.

Expected rate of return means if you buy this vehicle let's say 10 lakh rupees,

then whatever risk you are taking and efforts you are making,

Whatever risk you are taking, whatever hard work you will do to run it on the route

So for that you would like some returns,

Now that 10% or 15% or 20% can be whatever you have in mind,

Depending on the Risk.

So this is one method of your expected return.

So now we will see how we can apply the idea according to the expected return.

Another way is Cost of capital.

Cost of capital means either there is a way to calculate the expected return on your own.

that I will take a certain percentage on a certain risk.

Another way is that you can also take a loan on that.

So The more you take the loan,

the more your cost of capital can be reduced.

Now we will see its example in both the ways

we will try to calculate the discount rate.

After that you will know whether you should invest in the project or not.

So if your NPV @ Particular Discount Rate whatever your expected return is,

On that, if your NPV is positive, or it's more than zero,

then you can accept that project.

And if NPV @ discount rate becomes less than zero, becomes negative

then you will reject that project.

You will not invest money in that business or investment.

Now let's talk about the expected return

How you can categorize in Expected Returns

So you can make categories according to the risk

The higher the risk, the higher the returns you can expect.

This is a very natural thing, it's a law of Economics.

If you take more risk then your expectation of returns also increases

So what can you do, you can make this category of risk.

let's say the category of risk if we make 5 categories A, B, C, D, and E.

and let's say a category that is negligible,

I write negligible here.

There is a negligible risk in it.

And let's say there is low risk within the B category.

Within the C category, we assume there is medium risk.

There is a high risk within the D category,

Very high risk within the E category,

In this way we made categories.

Now we will put the expectation of our returns here,

So now you say that if suppose I have absolutely zero risk.

I am happy with this return even if I get only

FD interest rate or a little more than that.

You say FDs returns is 7% as on today's date,

So I am also happy with 8% return.

if I am going to get this money, so 8% is enough for me,

For low risk category you say I want 12 per cent returns,

I won't do a project for less than that I will not drive any car,

In the medium Risk, you may keep your expectations of 15%.

In high risk, you can keep the expectation of 20%.

And under very high risk, you may be driving on a route

where there is no surety,

It is a brand new route,

So now there can be very good returns

there can also come less, but you say if I don't get good returns

then why should I take the risk of new route,

why do I have to test

I have high expectation of returns that's why I am ready to take that risk.

I might get pretty good returns on the new route,

get a lot of traffic, no one drives there yet.

So this is the way according to the expected returns

you have seen that, I want so many returns,

can you think in your company or as an individual,

that you are expecting returns according to the amount of risk you are taking,

Similarly, you can apply this concept of returns to your investments as well.

If you invest money in FD then your risk is very less, you can be happy with 7%.

In Provident Fund, 8 - 8.5 % is available but your money gets locked.

Then in Mutual funds you get returns of 12 to 15 percent.

So over there you have to take a little bit more risk.

Then according to this, suppose you start investing in direct stocks,

then your risk capitate increases.

you expect 20 to 25 percent there.

So in this way you can calculate your expected returns

for any investment or any business.

Another way is the Cost of capital.

Now the cost of capital is of two types, one is the cost of loan.

that if you took a loan from someone, took a loan from a bank.

So there you have to pay an interest rate of 10 to 20 percent.

Now 10% means if there is a secured loan,

The interest rate for the vehicle can be 10%.

And if you suppose you are taking a business loan,

So it depends on your company's standing.

interest can be 15 or 18 or 20 percent.

So I've taken 10 to 20 percent range over here.

What is meant by Cost of Equity,

that is your opportunity cost of capital

that if you had put this money elsewhere, how much returns would you get?

Or if you have raised money from an investor,

Raised money from a venture capitalist.

or has raised money from a private equity firm.

then what is their return expectation?

So now this is the low expectation, it is basically 15%.

then the expectation with a stable company.

As the risk increases, the investors also increase their expectations of returns.

So, in many cases, it becomes 40 to 50 percent, especially in the case of Startups.

So the growth rate in early stage startups is very high.

That's why venture capitalists put money in there too,

And the expectations of their returns go up.

So this is equity, these are basically your shares.

So you basically dilute the shares accordingly your cost of capital increases.

So what are you doing in the loan,

that you are taking money at a particular interest and not diluting your shares.

it's a risk in equity that you are diluting your shares.

So according to this, you can get a discount rate according to your cost of capital.

Let us understand this with an example.

Let's say in Equity now we assume you are investing your own money.

So your Equity is 100%.

100% equity because your own money is being invested,

You didn't raise any money from any investor.

So you say now because I am taking risk then,

I will try that my minimum percentage of return must be 20%.

So you would say that my expectation is 20%.

So 20% is your Discount Rate straight away,

Or if you dilute some equity, or took some money from someone,

and gave them your shares of 20%.

And he also imposed a 20% discount rate on his expectation of 20%.

He valuate your company,

Even then your discount rate becomes 20%.

Now let's take the second example let's say you take Equity plus loan.

let's say you take this car on 80% loan.

Let's assume a loan of @10%.

So 80%@10% loan is done

and the rest of 20%.

That is your 20% @ 20% cost of equity.

cost of equity.

What we talked about equity here, we took 20%.

you have taken 20% of the equity itself here

And you are taking 80% of the money according to the 10% loan.

So what is your cost of capital?

So, it will be, I write here COC, cost of equity =

0.8. 80% of 10%.

plus 20% of 10%. so 0.2 x 20%

of it became 8 percent and it became 4 percent

So this cost of capital of your project becomes 12 percent.

So you can take a discount rate of 12 percent here,

because you also took some money from loan.

So now you are investing only 20% of your money.

Bank is taking risk of 80%.

So 12 percent, this is basically the project that we are talking about now,

So now we are not talking about equity here,

In equity, you are getting only 20% discount rate.

Overall Project discount rate is of 12%.

So this is the way to get your discount rate,

Now let us see this in Microsoft Excel,

that how we do its actual calculation?

Now let us see this in excel.

which we gave the example that should we invest in that project or not.

So I have plotted all these cash flows here year wise.

In year 0 we had invested ₹ 10 lakh, so I put this in negative.

We get a net cash flow of Rs 1.5 lakh in year 1.

2 lakh in year 2, 3 lakh in third year.

2.5 lakh in year 4.

and 6 lakh in year 5, that we talked about,

we sold the car for 4 lakh and 2 lakh from operations.

So the total 6 lakh in the year 5.

Now we would like to calculate our Net Present Value here,

and on what percentage we should calculate the discount rate.

So first, we will calculate it at 12 percent

Let's say if we had taken a loan,

would this project be viable for us?

Our expectation becomes 12 percent at that time.

Because we take 80% of the loan and the remaining 20%

we had to spend from our pocket Out of 10 lakh,

2 lakh out of my pocket and 8 lakh we would have taken a loan.

2 lakh money was spent from my pocket, on which I will get 20%.

And you will get 12% in the overall project.

So let's calculate 12 percent of NPV.

So I told you the formula of NPV calculation, in the NPV video.

So if you haven't seen that video then do watch it.

=NPV

Let's open the bracket here we have to enter the rate

This rate is your discount rate.

Here we will put 12% So it's basically 0.12.

we will select all the value here,

we will press enter here,

So here's our NPV is positive.

So this means it will give us 12% returns.

So in this project if we take 80 percent loan.

So we can invest in this project.

so our investment of 2 lakh,

we will get 20% and overall investment of 10 lakh,

we are getting returns of 12%.

Now second, let's say our expectation is of 20%

and suppose we are investing all the money ourselves.

So I gave you an expectation of 20% in 100% equity.

It is a high risk project.

So if we invest our own money then our expectation will be 20%.

Now let us calculate the NPV.

So if we calculate NPV,

So here the rate will become 0.2,

we will select all the values ​.

and we will press enter.

Now see here the value has come in the negative

This project is not viable.

that means it cannot give you 20% returns.

Negative here does not mean that the project is in loss.

but this project may not have the potential to give you more than 12% returns.

It is giving you maximum returns of 12 - 13 percent.

Just getting positive here.

Values ​​are becoming too negative in the 20%.

That is, it is going to give returns only around 12 - 13 percent.

So, when you calculate your NPV on Expected Returns.

So you just see positive and negative.

But now if we want to calculate how much our value is added.

how much profit am I able to earn if I am investing 10 lakh in it.

It's also important for me to know.

Now that basically works for you in different years.

money is coming in different years,

then you have to calculate its present value.

So the present value that you will find out,

and NPV, that will be taken out only on risk-free returns.

give a little attention to this.

Discount rate

Now you will get the risk free rate, you will no longer enter your expected returns here.

because in Expected Returns, you only want to see

that NPV must be positive.

Which means you have to be sure what percentage you will get the returns.

Now if you will calculate NPV on risk free return,

So now let's take a look at it,

=npv, if you take 7% return here.

I am taking 7% risk free return of FD.

If you think that this risk free return is 8% for you

then you can also take 8%.

Now here we will select all these cashflows and press enter.

So look at this here it's in dollars, I removed it,

I'll select it in numbers.

So you see how much value is being added here.

The car will earn ₹ 1,66,616 for you.

it simply means this.

Because the amount of risk you are taking

and the amount of efforts you are making is worth 1,66,000.

If you invest 10 Lakh rupees in today's date,

So that car or that project will earn you ₹ 166616 in today's present value in terms.

And it is value-added in your company.

Whatever risk you took and worked hard for it.

I think I'm all clear over here.

So here when we calculated the NPV,

we were making sure that we get returns of 12 percent.

Here we tried that its returns of 20% will come to you or not.

If it was not coming definitively, then this value came in negative

You get the real value add and according to the risk free return of 7%.

How much profit will you actually get at present value?

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