1 00:00:00,500 --> 00:00:06,950 In this lecture, we are going to discuss internal rate of return, also known as Iara. 2 00:00:08,810 --> 00:00:17,210 Like NPB, Iora is also used to evaluate and represent how good an investment opportunity is. 3 00:00:18,970 --> 00:00:21,430 However, there are some differences between the two. 4 00:00:22,620 --> 00:00:27,920 So let's first understand what Iran is and then we will compare it with an bivy. 5 00:00:30,330 --> 00:00:38,570 Iraq is simply the rate at which present value of your future cash flow is equal to the initial investment 6 00:00:38,570 --> 00:00:39,050 you are doing. 7 00:00:41,450 --> 00:00:49,850 So basically, if I invest a thousand dollars today and get 600 dollars at the end of each year for 8 00:00:49,850 --> 00:00:50,960 the next two years. 9 00:00:52,920 --> 00:00:58,920 I will first find the present value of these cash flows, which is given by six hundred, divided by 10 00:00:58,920 --> 00:01:05,640 one plus are raised to Power-One and six hundred divided by one, plus are raised to the power to. 11 00:01:06,120 --> 00:01:08,490 This is for the first year and this is for the second year. 12 00:01:11,220 --> 00:01:14,940 I equate this with the initial investment that I am doing. 13 00:01:15,920 --> 00:01:22,190 When I solve this equation for the answer that I will get is the internal rate of return. 14 00:01:24,960 --> 00:01:29,430 And in this example, the Ayata is coming out to be 13 percent. 15 00:01:31,580 --> 00:01:37,430 The other way of looking at it is that you can imagine that you have just bought a thousand dollars 16 00:01:37,430 --> 00:01:38,480 in a bank account. 17 00:01:39,490 --> 00:01:42,640 Which is giving you 13 percent compound interest. 18 00:01:44,680 --> 00:01:49,060 Then you can withdraw six hundred dollars at the end of last year. 19 00:01:50,380 --> 00:01:56,590 So at the end of the first year, the interest earned would be 13 percent of thousand dollars, which 20 00:01:56,590 --> 00:01:57,730 is 130 dollars. 21 00:01:58,450 --> 00:02:02,470 So the total at the end of last year is one thousand one hundred thirty. 22 00:02:03,130 --> 00:02:06,090 You withdraw 600 dollars at the end of last year. 23 00:02:07,180 --> 00:02:12,160 So the net balance in your account at the end of last year is 530 dollars. 24 00:02:13,370 --> 00:02:20,150 Now, one five thirty dollars, you get 13 percent interest, which makes it a total of six hundred 25 00:02:20,150 --> 00:02:20,600 dollars. 26 00:02:21,580 --> 00:02:25,600 So at the end of India, you can withdraw this six hundred dollars. 27 00:02:28,860 --> 00:02:37,050 I've shown you this example to make the point that Ayata is equivalent to compound interest rate at 28 00:02:37,050 --> 00:02:39,400 which you can achieve the same cash flow. 29 00:02:39,930 --> 00:02:46,290 So if you have an initial investment of a thousand dollars and this compound interest rate, you can 30 00:02:46,300 --> 00:02:49,470 achieve the same future cash flow as shown in the example. 31 00:02:53,070 --> 00:02:58,370 Now, how can we use Iraq to say whether an investment opportunity is good or not? 32 00:03:00,360 --> 00:03:07,680 Once you find Ayata, you can compare it with the best possible risk free rate or the rate at which 33 00:03:07,680 --> 00:03:08,880 you have raised the capital. 34 00:03:10,030 --> 00:03:17,710 If Ayata is greater than this rate, it means that this opportunity is better than the best risk free 35 00:03:17,710 --> 00:03:18,490 option available. 36 00:03:20,160 --> 00:03:22,290 So we can say that it is a good opportunity. 37 00:03:24,050 --> 00:03:30,230 Similarly, if you have two or more investment options, you can compare their IRR to decide which is 38 00:03:30,230 --> 00:03:32,120 giving better return on investment. 39 00:03:34,500 --> 00:03:42,400 That higher return on investment that is higher, Ottoway does not mean higher profits. 40 00:03:43,840 --> 00:03:48,760 In absolute terms, higher profit is given by the project, which is higher and Billy. 41 00:03:50,530 --> 00:03:56,770 And it is not necessary that the project with hired IRR will also have hired and bevvy. 42 00:03:58,720 --> 00:04:00,580 Let me show you a simple example for this. 43 00:04:02,030 --> 00:04:07,970 Suppose you have two investment options in option A. You're investing a thousand dollars. 44 00:04:09,060 --> 00:04:13,140 And in the next year, you'll get back fifteen hundred dollars. 45 00:04:15,120 --> 00:04:18,900 Now, the risk free rate of interest is 10 percent. 46 00:04:20,280 --> 00:04:26,720 Using these three values, you can calculate the present value for this option, which comes out with 47 00:04:26,730 --> 00:04:28,920 360 three point six dollars. 48 00:04:30,060 --> 00:04:37,290 So the net present value of option A is three sixty three point six dollars, and if you calculate internal 49 00:04:37,290 --> 00:04:41,950 rate of return on this investment, it is coming out to be 50 percent. 50 00:04:42,330 --> 00:04:47,040 So it is basically fifteen hundred minus thousand by a thousand, which is 50 percent. 51 00:04:48,040 --> 00:04:53,770 Similarly, when you do the same calculations on option B, where you are investing two thousand dollars 52 00:04:54,160 --> 00:05:00,460 and getting a return of twenty seven hundred fifty dollars in the next year, the IRA comes out with 53 00:05:00,460 --> 00:05:04,990 thirty seven point five percent, whereas the present value is five hundred dollars. 54 00:05:06,010 --> 00:05:11,680 Notice that the IRR of Option A. is more than IRR of Option B. 55 00:05:14,020 --> 00:05:23,110 But the pewee of option is less than option B higher ayata suggest that the return of investment is 56 00:05:23,110 --> 00:05:23,590 higher. 57 00:05:24,510 --> 00:05:30,210 So on the thousand dollars that you invested in option A., you are getting 500 dollars extra. 58 00:05:31,210 --> 00:05:37,810 Whereas on the two thousand dollars you are investing in option B. you're getting only 750 dollars back, 59 00:05:38,650 --> 00:05:42,830 so the return on investment is higher in option A.. 60 00:05:43,600 --> 00:05:50,980 However, the net gain that you get an option, it is only 363 dollars as compared to option B. 61 00:05:52,670 --> 00:05:59,720 So out of these two options, depending on what your ultimate agenda is, if you want to maximize gains, 62 00:05:59,870 --> 00:06:02,320 option B is the right option for you. 63 00:06:02,810 --> 00:06:08,210 And if you want to maximize our way, then option A is the best option for you. 64 00:06:09,660 --> 00:06:13,890 Now, let us go to a software tool and learn the implementation of Ayata.