IRR (Internal Rate of Return) - Explained in Hindi - YouTube

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Namaskar, my name is Mukul & you are welcome to Asset Yogi

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In this video, I am going to discuss to you about, i.e. Internal Rate of Return

Which we call, IRR in the short form

Just like I discussed in my Net Present Value video; if you want to invest in any project, business

Or you want to evaluate any investment product

Just like Net Present value is a financial calculation which helps in decision making

Same, IRR also helps you in decision making

For example, Let's say you invest 10 lakh, same as the example I have given you in the Net Present value video

Let's say, you have a car renting business & you invest 10 lakhs in a car

Then in 5 years, let's say you get 1.5 lakh in a year or 2.5 lakh next year

Let's say, you sell the car after 5 years & you get some amount for that

How much is its return?

Here, you want to calculate annual returns

Then, how is it calculated? We will see that is this video

If I give another example; if you want to evaluate any investment product like any FD

The interest rate of the bank goes up & down every year

So, if different income is generated from FDs or Saving accounts, every month

Then, the net returns you get are also called the IRR

In this video, we will understand, How is IRR calculated & what are its concepts?

SO, watch the video till the last, let's move to the blackboard

We will understand the concept of IRR with an example

Let's assume, a company want to invest 10 lakh in a project

What returns will they get on these 10 lakhs?

So, they want to know these % or annual returns

If they can find out these annual returns, then it will be easy for them to take the decision, whether to invest here or not

Similarly, we have calculated NPV in one of our videos, which is also a matric through which

We know whether; we should invest in a project or not

So, the % annual returns are known as IRR (Internal Rate of Returns)

IRR is a metric to estimate the profitability of a project, business, or investment

In other words, it is a discount rate at which NPV of a project becomes 0

For example

We have already talked about discount rate in our previous NPV video & future & present value video

Internal rate of return basically is a calculation of the discount rate at which NPV of a project becomes 0

I will tell you the reason of why we take the value of NPV, 0

In other words, it is the annualized rate of return from an investment

This are the annual returns in %

How soon will you get back the money you have invested

As we are talking about the rate of return, that means, how soon will we get back the money we have invested

Or how much % we will get; every year

Let's say, you invest 10k somewhere

And you get 12k next year from that investment

Then, how will we calculate its Internal rate of return?

The formula of NPV is

NPV= (FV0) / (1+r)^o + FV1/(1+r)^1

As; it is 1st year, so, we will take period value 1

Similarly, if it was of 4-5 years, then we would have extended it further

If we calculate in this case, then

Here, NPV is 0

0= -10,000/1 + 12,000/(1+r)^1 , if we further calculate it, then

10,000=12,000/(1+r) , so it will become

(1+r)=12,000/10,000=1.2

r= 1.2-1 = 0.2 = 20%

So, in this case, the rate of return (IRR) is 20%

Here, the calculation is simple because we were talking about only 1 year

If I complicate it & do it for 2 years (0, 1, 2)

0 year= 10,000, 1st year=6000, 2nd year=6000

The calculation here, will be

0 = -10,000 + 6,000/(1+r)^1 + 6,000/(1+r)^2

I have only increased 1 year & it has become so complicated to calculate 'r'

In this case, you can use hit & trial, which means, you can put different values of 'r' & try to solve the equation

Let's say, you will use 10% then 11% or 12%, 13%, 14%...and so on

On whatever % both the values will be close to 10,000, then your rate of return will be close to that

So, when you will calculate, it will be close to somewhat 13%

Here, in general day-to-day scenarios, the equations are more complicated than this example

If we discuss the example which we have taken in Net Present Value, then

A car company is evaluating whether to start a new route. what will be the annual returns from the project/IRR?

If the returns are more than or even meet the expected value, then definitely they can invest in that project

If I plot it on a time line

Let's assume, there is an investment of 10 lakhs on the 0th date

We will see the cash flow of year (1, 2, 3, 4, 5)

Let's say, the cash flow in 1st year is 1.5 lakh

2 lakh in second year

3 lakh in the third year, 2.5 lakh in the fourth year

Then the company thinks that they will sell the car after 5 years in approx. 4 lakh & will get 2 lakh from the operation

These 4 lakhs are called terminal cash flow & these 2 lakh are coming from the operation

So, the total cash flow is 6 lakhs in the fifth year

We will apply the same formula to find out IRR

NPV=(FV0)/(1+r)^0 + (FV1)/(1+r)^1 + (FV2)/(1+r)^2 + (FV3)/(1+r)^3 + (FV4)/(1+r)^4 + (FV5)/(1+r)^5

So, when you will substitute the figures, you will get this type of equation

Here, it is difficult to find out the value of 'r' because the equation has become so much complicated

So, to solve these types of equations easily, we use Microsoft Excel or Google Spreadsheet

We will see, how these calculations are done, with an example

Here, we have taken 2 examples

In year 0, we invested 10,000 & then we get 6,000 in the first year & 6,000 in the second year

In the second example, we will calculate IRR for the 'car project'

Firstly, we have to plot years from year 0 to year 5, the project is of 5 years

If the project period is long, then we can extend the year plot

Then, we have to take Net Cash Flow, which means, money left after the expenses of operation

In the 0th year, we invested 10,000, that is why we will put the (-) sign

Then in years 1&2, we are getting money, that is why it will be positive

To calculate the IRR, you will type "=irr", it is an formula in the excel or spreadsheet

You will do the open bracket (), and select all the Net Cash Flows

After selecting them, close the bracket & press Enter key

And by doing this easy steps, you will get the IRR

You can do it by hit & trial method too, but it will take much longer time

As I have said, if you put the value of 'r' near 13%, then you will get a value close to 10,000

So this will be calculated, this way

Similarly, we have to calculate the IRR for the car project

We will put the value of Net Cash Flow in the year 0, i.e. 10lakhs, brackets also mean negative

Then 1.5 lakh, 2 lakh, 3 lakh, 2.5 lakh & then 6 lakh are the net cash flows

In the fifth year, we sell the car for 4lakh & got 2 lakh from the operational cash flow

So to calculate IRR, we will type "=irr" & select all the cells of NCF & then press the Enter key

Here, the returns are 12.2%

So, when you will evaluate whether to invest in this or not

Then management will see how much returns we are getting; if the returns are more than that they expected

Then definitely, the company can invest here

Here, if the expectation of management is 12%, then they can invest

But if the expectation of management is 15%, then they will not invest in that project

Instead of this, they will run the car on a different route or invest 10 lakh somewhere else

So, you can also take your investment decisions like this

You can also evaluate whether to invest or not

It can be an investment product, FD, Mutual Fund, any type of product

Or you want to invest in a new business or have a franchise, then you can calculate IRR & NPV

In the last video, I told you that NPV should be +ive

If NPV is positive, then you can invest in that project

If you haven't watched my NPV video, then do watch it

If you take the combination of NPV & IRR, then it will become easy to take a decision

So, that all for this video, I actually enjoyed making this video

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