I would like to ask about IRR, Is it correct what I am understanding on IRR formula when both NPV are negative? Thanks a lot sir.
if NPV at 15% is -3200
NPV at 13% is – 1000

IRR= 15%-(3200/2200 X 2%)= 12.09%
(OR)
IRR= 13%-(1000/2200 X 2%)=12.09%

What formula? I do not use a formula.
Passing the exam is not learning formula (calculations are only 50% of the exam) and what is more important is understanding.

First of all thank you for all the great lessons here on opentuition. I think we all really appreciate your effort.

I would have just one question. Since they call it “internal return”. Would it be sufficient for the exam to calculate the IRR by dividing the cash outflows with the sum of cash inflows to the power of 1/n (periods)?

We are simply looking at the difference between the two NPV’s.

So if one of the is +10 and the other is -5 then the difference is 15
If one of them is +10 and the other is +5 then the difference is 5
If one of them is -5 and the other is -15 then the difference is 10.

I think my question is like this one, so I decided to post under this question.
10% – This is 50 000 NPV
15% – This is -10 000 NPV

If we start from bottom to top// (15-10)= 5% increase in interest which corresponds to decrease in NPV of 60 000 (-10 000 – 50 000), so +5% and -60 000.
In this case we have -5/6*5. So it turns out IRR lower than 10% which is wrong. I am kind of confused ……Can you explain once more this part with signs.

Hi John, thank you for this lecture. I got a bit stuck working through my text book and couldn’t see how to get the answer (no explanation in text). I see it now – very simple 🙂

No!
Different guesses will give a slightly different answer (and that is fine) but it will only be slightly different. 18.38% is much too much different!!!

At 13% you should have got an NPV of +1170.
We already have that at 10% the NPV is +6660.
So over a change of 3%, the NPV falls by 5490 (6660 – 1170).

So the IRR is 10% + (6660/5490) x 3% = 13.64%

(or, if it more obvious to you, IRR = 13% + (1170/5490) x 3% = 13.64%)

Dear John,
Can you please let me know the brief meanings for “cost of capital”? I have searched on net but they are not giving a good brief understanding

Though I am aware of concept but I cant make proper meanings of it.

It is the cost to the company of their long-term finance – effectively the interest that they are having to pay on their borrowings.

The long term finance borrowed from debt lenders will involve paying interest.
The long-term finance raised from shareholders does not involve paying interest, but shareholders will be requiring dividends and that is effectively like paying interest.

(You have posted this under a lecture on internal rate of return, but there is no direct connection. You should watch my introductory F9 lecture and also my lectures on Cost of Capital itself.)

Technically IRR is the rate at which NPV becomes zero. So if the current COC used to appraise the project is more than IRR means NPV will become negative which will lead to rejection. At the same time a current COC used for the appraisal below IRR will give a positive NPV which will lead to acceptance. So if the current return rate is more than IRR means should we reject the project. Please correct me if i am wrong.

Yes – the definition of the IRR is that it is the rate of interest at which the NPV is zero.

What you have written is correct (although your next to the last sentence says ‘the current return rate…..’. You mean ‘the current cost of capital….’ (But you already said that earlier 🙂 )

Thanks Sir Its a Great Lecture, However I was confused at the part where you instead of subtracting a Positive and Negative NPV you added them, but in the end of the lecture in different example You Subtracted Both Positive NPVs to get IRR, is this a trick or a formula? Anyways thanks sir 🙂

I Remember When I was in school and when I was taught Algebric Division, The Sign of the Second number was changed whenever we try to add or subtract For E.g we wrote +20 and below it +15 but in algebric division rule we change the sign of second number i.e now it is -15 so we subtract 15 from 20, Similarly in Vice Versa +25 is written and below -10 so we change the sign of second number i.e +10 so we added both 25 + 10. hmm now I think I Understood,its the same rule which applies here Thank you Sir 🙂

Thanks alot!
Yes The formula is kinda hard to remember, especially during the exams u could get confused with the symbols. This method is simpler and easier to understand.

Dear john
I was practicing opentution practice math number 7 OPERA LTD,here I have a few questions as follows:

1.while doing part a why have not we calculated the average rate of return for current year?we calculated it normally and then we compared with the forecasted average rate of return.should not we calculate the average rate of return for current year and then compare it with the average return of the project proposed?i mean why not both are average rate?

2.why did not we include the 2m scrap value while calculating capital employed.should not it be included in the final year as a cash inflow?or it has something to do it with depreciation??pls make my understanding clear on this matter.

3.why did not we calculated the t0?we started from year 1,but should not we been make the initial capital employed at the t0 and then the first addition in the year 1?
4.while calculating the average capital why did not we follow the formula that is initial capital+scrap / 2.?

my questions could have been silly but Im really looking forward to have a reply from you to make my understanding clear.
Thanks in advance.

Thanks you for the lecture.. I practised the June 2009 paper question 2. Im getting an IRR of 14,22% at a DF of 15%. The answer is giving a IRR of 18.22% when they discount at 20%. Does this mean my answer is wrong? there is a difference of 4% in the IRR.

If you discount at 15% the NPV is +126,931 and so the IRR must be higher than 15%.

We already know that at 10% the NPV is +366,722.

And so over a change of 5 percentages, the NPV falls from +366,722 to +126,931 which is a fall of 239,791

Starting from 15% we need the NPV to fall by 126,931 to get to zero, and so the IRR = 15% + (126931/239791 x 5%)

This comes to an IRR of 17.65%. (It is still a bit different from the examiners answer but the difference is small and is because it is not a linear relationship. This would still get full marks.)

Finding the IRR always involved making two guesses and then approximating between them – as I have done in this lecture. You can write what I have done as a formula but there is not much point since it doesn’t make it any easier or faster and you are not given a formula for it on the formula sheet. Also, since the whole point of the exam is to make sure you understand what you are doing, it seems rather silly to learn a formula that does not speed things up just for the sake of it.

Now this is what I call training future Finance Managers not just some of the stuff that other providers give where you are just told learn this formulae withouth a full understanding. This is top class qaulity thank you Mr Moffat and God bless everyone at Open tuition may you continue to be a sucess.

Dear Sir, I read a book saying that “accept the project if the IRR is higher than the cost of capital”. I bit confuesed with this sentence.Your lecture note saying that, eg, if at 10% COC +’ve NVP6,660 & If IRR let say at 13% it will be break even. If to accept the project with higher IRR, Is that mean it’s beyond 13%….Pls advice..

@sharman, You misunderstood. If the cost of capital = 13% (the IRR) then the project will break-even (i.e. the NPV will be zero).

If the cost of capital is less than 13% then the NPV will be positive and the project should be accepted. If the cost of capital is more than 13% then the NPV will be negative and the project should be rejected.

@aaamna, when it starts playing, you can skip to anywhere you want in the video, and it will start playing, you do not have to watch it from the beginning,

May says

Dear Sir,

I would like to ask about IRR, Is it correct what I am understanding on IRR formula when both NPV are negative? Thanks a lot sir.

if NPV at 15% is -3200

NPV at 13% is – 1000

IRR= 15%-(3200/2200 X 2%)= 12.09%

(OR)

IRR= 13%-(1000/2200 X 2%)=12.09%

John Moffat says

Correct 🙂

Elena says

Hello

To make the mormula more clear it is worth not to use “%” in the second component, which is “percentage point”, not “percent”.

If to apply your formula as is, we have the calculation:

12% + 6800/11200*8% = 12% +0.048 = ?

John Moffat says

What formula? I do not use a formula.

Passing the exam is not learning formula (calculations are only 50% of the exam) and what is more important is understanding.

Zoran says

Dear Sir

First of all thank you for all the great lessons here on opentuition. I think we all really appreciate your effort.

I would have just one question. Since they call it “internal return”. Would it be sufficient for the exam to calculate the IRR by dividing the cash outflows with the sum of cash inflows to the power of 1/n (periods)?

Kind regards

Zoran says

Sorry, the other way round…cash income / cash outflow

Zoran says

Please ignore; just noted that I had a random luckshot by making a typo.

Moloantoa says

hi John,

is there any margin to set between the two guessed rates? i.e say 5 as a difference according to the illustration above?

John Moffat says

No – there is no special margin 🙂

Bhagat says

Mr. John Moffat, your lectures are steady as always. I feel blessed learning under your guidance 😀

John Moffat says

Thank you 🙂

clss says

Hi

Is the video working properly? I cannot get past 3.13 minutes, at 3.13 it then skips back to 3.08,

John Moffat says

The video is working fine. Go to the support page (the link is above) and you will find help there.

aliimranacca007 says

if 1 NPV IS + AND 1 – we add both …if both + we subtract ..if both negtive then we also subtract ?

John Moffat says

Don’t simply learn a rule – you must make sure you understand what is happening and then you don’t need a rule.

aliimranacca007 says

according to rule +,-= – but in Q you make add both , +,+= + , -,- = +

John Moffat says

We are simply looking at the difference between the two NPV’s.

So if one of the is +10 and the other is -5 then the difference is 15

If one of them is +10 and the other is +5 then the difference is 5

If one of them is -5 and the other is -15 then the difference is 10.

Lilit says

I think my question is like this one, so I decided to post under this question.

10% – This is 50 000 NPV

15% – This is -10 000 NPV

If we start from bottom to top// (15-10)= 5% increase in interest which corresponds to decrease in NPV of 60 000 (-10 000 – 50 000), so +5% and -60 000.

In this case we have -5/6*5. So it turns out IRR lower than 10% which is wrong. I am kind of confused ……Can you explain once more this part with signs.

John Moffat says

For a difference in NPV of 60,000, the interest rate changed by 5%.

If you start from the 10% guess, then we need the NPV to change by 50,000.

So it must be higher than 10% by 50/60 x 5%, which is 10% + 4.17% = 14.17%

awesome wajid says

John this lecture isn’t opening, maybe file has corrupted!! All other lectures r working fine, Sir

opentuition_team says

this lecture works OK too, reload the page.. clear cache if needed..

fahim231 says

This is by far the best way to calculate the IRR. Thanks John that was great.

skelf says

Hi John, thank you for this lecture. I got a bit stuck working through my text book and couldn’t see how to get the answer (no explanation in text). I see it now – very simple 🙂

John Moffat says

You are welcome – I am pleased that it is making sense 🙂

hope says

Nice lecture, the NPV and IRR is making sense to me now. Thanks alot John.

Gregory says

Dear John, i tried another cost of capital of 13% instead of 15% and got IRR= 18.38%. will this also be correct ?

Gregory says

at 12% sorry

John Moffat says

No!

Different guesses will give a slightly different answer (and that is fine) but it will only be slightly different. 18.38% is much too much different!!!

At 13% you should have got an NPV of +1170.

We already have that at 10% the NPV is +6660.

So over a change of 3%, the NPV falls by 5490 (6660 – 1170).

So the IRR is 10% + (6660/5490) x 3% = 13.64%

(or, if it more obvious to you, IRR = 13% + (1170/5490) x 3% = 13.64%)

Gregory says

thank you sir

Queenie says

Great lecture really helped me to understand the concept of NPV & IRR! Thank you John your a fab lecturer!

acca2050 says

Dear John,

Can you please let me know the brief meanings for “cost of capital”? I have searched on net but they are not giving a good brief understanding

Though I am aware of concept but I cant make proper meanings of it.

Many Thanks

John Moffat says

It is the cost to the company of their long-term finance – effectively the interest that they are having to pay on their borrowings.

The long term finance borrowed from debt lenders will involve paying interest.

The long-term finance raised from shareholders does not involve paying interest, but shareholders will be requiring dividends and that is effectively like paying interest.

(You have posted this under a lecture on internal rate of return, but there is no direct connection. You should watch my introductory F9 lecture and also my lectures on Cost of Capital itself.)

acca2050 says

I am grateful to you for coming to my confusion and being so quick. I do apologize for the mistake.

Many Thanks

krish says

Dear sir,

Technically IRR is the rate at which NPV becomes zero. So if the current COC used to appraise the project is more than IRR means NPV will become negative which will lead to rejection. At the same time a current COC used for the appraisal below IRR will give a positive NPV which will lead to acceptance. So if the current return rate is more than IRR means should we reject the project. Please correct me if i am wrong.

John Moffat says

Yes – the definition of the IRR is that it is the rate of interest at which the NPV is zero.

What you have written is correct (although your next to the last sentence says ‘the current return rate…..’. You mean ‘the current cost of capital….’ (But you already said that earlier 🙂 )

hamzaharoon says

Thanks Sir Its a Great Lecture, However I was confused at the part where you instead of subtracting a Positive and Negative NPV you added them, but in the end of the lecture in different example You Subtracted Both Positive NPVs to get IRR, is this a trick or a formula? Anyways thanks sir 🙂

John Moffat says

We need to look at the difference between the NPV’s.

The difference between (for example) +10 and -5 is 15. However the difference between +10 and +5 is 5.

Hope that makes sense 🙂

hamzaharoon says

I Remember When I was in school and when I was taught Algebric Division, The Sign of the Second number was changed whenever we try to add or subtract For E.g we wrote +20 and below it +15 but in algebric division rule we change the sign of second number i.e now it is -15 so we subtract 15 from 20, Similarly in Vice Versa +25 is written and below -10 so we change the sign of second number i.e +10 so we added both 25 + 10. hmm now I think I Understood,its the same rule which applies here Thank you Sir 🙂

Rana Mateen says

Peerless,the legend moffat.

sdmaalex says

Thanks alot!

Yes The formula is kinda hard to remember, especially during the exams u could get confused with the symbols. This method is simpler and easier to understand.

leonmatthew says

Dear john

I was practicing opentution practice math number 7 OPERA LTD,here I have a few questions as follows:

1.while doing part a why have not we calculated the average rate of return for current year?we calculated it normally and then we compared with the forecasted average rate of return.should not we calculate the average rate of return for current year and then compare it with the average return of the project proposed?i mean why not both are average rate?

2.why did not we include the 2m scrap value while calculating capital employed.should not it be included in the final year as a cash inflow?or it has something to do it with depreciation??pls make my understanding clear on this matter.

3.why did not we calculated the t0?we started from year 1,but should not we been make the initial capital employed at the t0 and then the first addition in the year 1?

4.while calculating the average capital why did not we follow the formula that is initial capital+scrap / 2.?

my questions could have been silly but Im really looking forward to have a reply from you to make my understanding clear.

Thanks in advance.

John Moffat says

Sorry to be a nuisance , but please can you copy and paste this question to the Ask the Tutor forum.

(The reason is that I do not have time to answer now and it will disappear from the list. I will answer when I get back from work)

fzinyemba says

Dear John

Thanks you for the lecture.. I practised the June 2009 paper question 2. Im getting an IRR of 14,22% at a DF of 15%. The answer is giving a IRR of 18.22% when they discount at 20%. Does this mean my answer is wrong? there is a difference of 4% in the IRR.

Thanks you

John Moffat says

Your answer is wrong 🙁

If you discount at 15% the NPV is +126,931 and so the IRR must be higher than 15%.

We already know that at 10% the NPV is +366,722.

And so over a change of 5 percentages, the NPV falls from +366,722 to +126,931 which is a fall of 239,791

Starting from 15% we need the NPV to fall by 126,931 to get to zero, and so the IRR = 15% + (126931/239791 x 5%)

This comes to an IRR of 17.65%. (It is still a bit different from the examiners answer but the difference is small and is because it is not a linear relationship. This would still get full marks.)

maggiemdeza says

good and straight forward lecture, thanks Mr. Moffat.

siti says

do we have any formula to guess the IRR rate?

John Moffat says

Finding the IRR always involved making two guesses and then approximating between them – as I have done in this lecture. You can write what I have done as a formula but there is not much point since it doesn’t make it any easier or faster and you are not given a formula for it on the formula sheet. Also, since the whole point of the exam is to make sure you understand what you are doing, it seems rather silly to learn a formula that does not speed things up just for the sake of it.

rodise says

MOFFAT RULES!!!!

K'Liscious says

Great lecturer. Thanks a mil Opentuition. I am understanding the text a lot better now thanks to these videos. IRR–check! on to the next.

chindub says

nice one…many thanks.

aeiza says

Stopped working.. Had to reload it several times, but couldn’t remume from where i wanted. Also says now ‘Server not found’. Help? 🙁

majid1984 says

This online lecture is fantastic, its clear and understandable…thank you

mmariba2000 says

Now this is what I call training future Finance Managers not just some of the stuff that other providers give where you are just told learn this formulae withouth a full understanding. This is top class qaulity thank you Mr Moffat and God bless everyone at Open tuition may you continue to be a sucess.

jewel086 says

Now it’s very clear to me about internal rate of return….it was very complicated when I tried to learn the formulae…thank u very much

arifajs says

Love Sir John Moffat! God bless you!

sharman says

Dear Sir, I read a book saying that “accept the project if the IRR is higher than the cost of capital”. I bit confuesed with this sentence.Your lecture note saying that, eg, if at 10% COC +’ve NVP6,660 & If IRR let say at 13% it will be break even. If to accept the project with higher IRR, Is that mean it’s beyond 13%….Pls advice..

John Moffat says

@sharman, You misunderstood. If the cost of capital = 13% (the IRR) then the project will break-even (i.e. the NPV will be zero).

If the cost of capital is less than 13% then the NPV will be positive and the project should be accepted. If the cost of capital is more than 13% then the NPV will be negative and the project should be rejected.

sophiayip says

let said i just studies from opentuition,it is enough for me prepare to exam?thank.

aaamna says

I’ve probably played this video atleast 30 times. It keeps stopping partway through and i have to wait through it all again and again!

admin says

@aaamna, when it starts playing, you can skip to anywhere you want in the video, and it will start playing, you do not have to watch it from the beginning,

misanvu says

Good work done.

groves says

just this small point on how to get IRR instead of the formula makes everything else fall into place. Fantastic thanks

eunice says

Surely, this some real great stuff and more so for free, God richly bless u guys.

sundushaikh says

these lectures are not running properly and stop after some time and i cant listen the whole lectures please help!!!

praveenkaur says

Great Stuff. Thanks a lot.

adigun22 says

i’m in love with open tuition. the clarity is on point. i can’t explain how happy i am cos i have struggled with this in the past. God Bless you all

harripool says

Spot on and simply explained. Much better technique than the formula

demmybaba says

God bless this organisation.Your lecture are straight to the point,current in line with the syllabus and free.