NPV vs IRR - Net Present Value and Internal Rate of Return Explained in Hindi - YouTube

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Namashkar, my name is Mukul and welcome to Asset Yogi

Where we unlock the knowledge of finance rather locking it

In the previous videos, we saw the calculations of NPV and IRR

That means if you are analysing/evaluating any investment or project

Then whether you should invest in it or not, you can find it out through the NPV and IRR calculations

But if you have multiple projects options like project 1, project 2, project 3

And if you want to find out the best project to invest in

Or the best investment with limited money

Then you can do both NPV and IRR calculations

But many times, there is a difference between them

There's a conflict in which according to NPV, project 1 is better

and according to IRR, project 2 is better

So in this video, we'll discuss that out of NPV and IRR, which metric is better

So stay tuned with this video till the end because this topic is very important

And usually, we have to do these investment analyses in normal life as well

Let's switch on the blackboard

Let's say a company has 3 choices to invest in, Project A, Project B, and Project C

Maybe the company is evaluating all the 3 projects

So there are 2 scenarios

1. There's no lack of funds and the company can either invest in or drop all the three projects

So the company is evaluating independently and can invest in any project whichever it likes

2. Funds are limited with the company

So maybe all the projects are good but they want to invest only in 1 or 2

So the company may give ranking to the projects

Let's say according to the company, Project B is the best

Project A on 2nd and Project C on the 3rd

So if they want to select only one project, they will select Project B to invest

So in this video, we'll understand how the ranking is done

As I discussed in Scenario 1,

If there are no constraints for funds and the company is independently evaluating all the projects

Then, in that case, we saw how can we find out whether to invest in a project or not

We saw that if the NPV is positive, i.e more than 0

at a discount rate of expected returns

That means if the expected returns are 12%

Let me write here 12%

So if the NPV is positive according to the expected returns

Wherever it gets maximum returns in any of its projects

So if NPV is positive according to that then that project is all set for a yes

In this case, all the 3 projects can be approved if they meet the criteria

Similarly, if IRR is greater than the cost of capital

Let's say you picked some money on interest rate

If you picked the capital on the interest rate and IRR becomes more than that

Then also we can invest in that project

For example, if the loan interest rate is 11% and the IRR is 15%

Then definitely it is greater and you can invest in such project

In such case, either all the projects can be accepted or all can be rejected

If both of these criteria meets

You can take a combined view as well by calculating both

Now in the 2nd scenario, if the funds are limited

Then the company will choose between these projects

So as we discussed that company will rank the projects like 1, 2, 3

That which one is the better project

This ranking depends on whether you're doing it according to NPV or IRR

So many times, a conflict is there and now let's see what type of conflict is there

So let me repeat once again that we're now discussing NPV vs IRR for the second scenario

Where the funds are limited and we want to select that

whether to do a single project, two or which projects can be selected on the basis of funds

In such a case, let's see the first scenario that what is the conflict of NPV and IRR on the size of the project

Now, how does this conflict happen? Let me explain with an example

Let's say there are 2 projects. Project A and Project B

Both the projects are for 1 year

In project A, the investment is Rs 1 lakh

So I wrote -1 lakh here

And after 1 year, Rs 1.5 lakh will come

In this case, the IRR came out 50%

The net present value came out 37,557.87

Now focus that at what rate I calculated NPV

So I calculated on 7% instead of 12%

Expected returns of the company can be 12%

But when you will compare 2 projects on the basis of NPV and IRR

Then you have to take discount rate as risk-free interest rate

Keep this in mind

So take this risk-free interest rate because and I am saying it

because you can get this risk free interest rate easily just by deploying the money in the bank

For example, if you invest in FD. I took the interest rate of FD, i.e 7%

So you just don't have to do anything and you'll get this money

So we always want that if we do a project, what better can we get

So if you calculate NPV according to 7%

Then this amount is the wealth added to the company

So in both cases, this is the real wealth added

That's why we calculated NPV at 7%

In project B, you're investing Rs 3 lakhs and the return is Rs 4,20,000

IRR is less here

Here IRR is 40% and earlier, it was 50% but

NPV is more here. It is 86,470

The difference between both is around Rs 50,000 in NPV

So according to IRR, project A is suitable

But according to NPV, project B is suitable because NPV is more

So which project should we select and which one is the better metric among IRR and NPV

So let me clear this out, NPV is a better metric

Why? Because it is giving actual wealth added

How much is the actual money you got in your pocket

So you got Rs 50,000 as the extra amount in your pocket

However, you did an extra investment

Maybe the rest of the 2 lakhs, if you would have invested here

Rs 1 lakh here and the rest of the Rs 2 lakhs in the bank giving 7% returns only

So if you have Rs 3 lakhs, it's better to choose project B

Because it will give Rs 50,000 extra in your bank account after 1 year

Thatswhy NPV is always better if there's a conflict between choosing the projects

Another conflict is in the timing

So let's take its example

Let's say you can invest Rs 1 lakh in project A and B both

Now we're not telling the difference in the amount, it is only there in the cashflows

But the amount is the same

In the first project, you get Rs 1.5 lakhs just after 1 year

The rest become 0 and you get all the money back in just 1 year

In the second project, you get nothing after the first 2 years but in the 3rd year, you get Rs 2,20,000

So in such case, the IRR in the first project is 50%

And in the 2nd case, it is 30%

And here also, you have to calculate the NPV at 7% on risk free interest rate

So NPV is the same Rs 37,557 and in the second case, it is Rs 74,379

So NPV is more here, right!

And IRR is more in the first case

So here also, you have to select the project according to the NPV only

So wherever NPV is more, wealth will be added more

Even though there is a difference between cash flows, timing, or size of the project

Then also, you have to see the final amount in your pocket

So you have to see this and that's why NPV is always a better measure

So take care of 2 things, 1st is the discount rate matters a lot here

There is very much confusion here, you'll get to see the graphs on this topic

And it creates very much confusion

So you have to take a risk-free interest rate and when you will calculate NPV

So take a risk-free interest rate, don't put expected returns and neither the cost of capital

Cost of capital means if you took some money on debt

Then you don't have to put that here and you have to put risk-free interest rate

Which can be earned without any risk and efforts

You don't have to take any risk and your money is in the bank which is growing automatically

You have to take this type of discount rate

Secondly, NPV is always a better measure if you have to choose between IRR and NPV

Because you get the actual wealth added with NPV

So the final amount in your pocket actually matters

So I think I covered all the scenarios of NPV and IRR

and I hope this concept is clear to you.

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