Time Value of Money – What is the IRR

Time Value of MoneyIRR, Yes.. Internal Rate of Return is very useful and important thing about finance. There is lot of ignorance about the concepts of Time Value of Money. Many times we are in the situation when we do not understand exactly how much rate of return we earn. There are so many such transactions we enter into even without knowing the rate of return which we are earning. Yes. In real life scenario we do not know the rate of return or to put in simple words how much interest rate we earn in a particular scenario.

Okay let me illustrate the following scenarios so that you will be able to understand what I wish to convey.
*  Suppose Mr. A Invests INR 5000 in each year for the period of 5 years. Then from the Start of 11 th year he gets INR 5000 per year for next 10 years. So what exactly is the Interest Rate enjoyed by Mr A?
*  Mr. X Invests INR 12000 at the beginning of the year for two years and then gets INR 1000 per month for one year, then gets INR 500 per month for one year, and then again INR 1000 per month for next year. In this case how much Interest he has earned.
Yes now you got what I wish to convey. Many times we land in a situation when apparently or intuitively we feel that this kind of transaction is favorable to us. Like in first scenario people tend to feel that they get INR 50000 against the investment of INR 25000. But they tend to ignore the time value of money of this kind of transaction. They tend to ignore what exactly interest rate or IRR ( Internal Rate Of Return) in such kind of scenarios. And interestingly many people do not have the tools to find the rate of return in such kind of situations. The scenarios mentioned above are not isolated or exceptional ones. In fact there are numerous of such kind of transactions.
Okay, now the question arises how exactly to calculate the IRR i.e rate of interest in such kind of situations. And the answer is Microsoft Excel. Yes! There are two amazing functions in Excel and that are IRR and XIRR. These two functions help to calculate the IRR within less than 10 minutes. In case of first kind of situation IRR function can quickly calculate the IRR where one has to plot year wise cash inflows and outflows. But in cases where there are month wise cash flows as mentioned in second scenario, XIRR function is more helpful. In XIRR you can plot date wise cash inflows and outflows. As I said within not more than 10 minutes you can find IRR.
Please check the following video where I have explained step by step and in detail how to use these two excellent functions of Microsoft Excel. In this video I have explained and calculated IRR for the above two scenarios.

I hope this video helps! If you like this article simply share it.

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Financial Mathematics with MS Excel: Time Value of Money