Okay. Today, I have after doing a review of last three weeks, emphasizing Week

three, picked up a game on IRR. And I've tried to show you through examples, as

hopefully always, the problems with this measure. And I have focused on this

measure as not something that I propose you use and certainly as not something

that's completely flawed but it's in the middle and that's when things become a

little bit dicey. So, let's walk through the properties of IRR. There are other

measures which I won't talk about. I'll talk about, I've talked about NPV and

we'll run with it after this for the entire class. I've talked about payback

and kind of pushed it aside, it doesn't make sense. Irr makes a lot of sense. But

here are the properties I'm concerned about. So, let's start. The first property

we said, is, does it make sense? And here, what I would like to do is I would like to

kind of scribble some thoughts. I know my writing is not the best in the world but

hopefully while I'm talking and writing it, it makes life simple for you. So, does

it make sense? Maybe. And the reason is lot of people like rates of return. They

come naturally to us, percentages of life. So, maybe it does make sense and maybe

that is what creates little bit of problem. However, I would put maybe with a

bunch of question marks because its, its, at a gut level, it makes sense. We

naturally gravitate towards it but that doesn't mean it is right, right? So, a lot

of things are seductive and seemingly right but there are issues and that is why

we learn and try to investigate. Unit of measurement. As I said, the make sense

part is a very broad question and now we are digging deep. So, what's the unit of

measurement? Remember, I told you that I think the more I think about life and more

I think about something that I know a lot about, I try to dig into what the heck is

going on. Now, what is the unit of measurement? In some senses, it's very

cool. It's unitary, right? It's a number, it's a percentage. So, that's cool. But

what the danger is, wh at is the relationship between this and her value

measurement? How do we measure value? We measure value in terms of something that's

acceptable right around.So, if I told you a project has 25 percent rate of return,

you may feel good about it, but you have to ask yourself, what does it mean in

terms of value measurement? And here is the problem, value measurement, usually,

would be either in dollars, or in rupees, or whatever your currency is. So, there's

really no connection between the two. And that's why you have the rule of thumb,

what? Even if you use IRR, what do you have to compare it to? The alternative

best. Why? Because that process hides value behind it. In other words, if IRR is

greater than R in a simplistic world, you are creating positive value. So, the unit

of measurement being a percentage, make you very cautious. Why? Because it's not

directly value. Benchmark, obvious? I think the benchmark is not obvious if

you're looking internally, right? So, what's the benchmark or is one better than

the other? That really is not a good thing. In dollars, it is, because it's a

measurement but in percentage, maybe nine. Okay? So, what is the benchmark? This is

the benchmark. So, if you dig deep and you realize that rate of returns are by

themselves don't mean much, you have to compare them with sum. What is the

benchmark? What would have I earned elsewhere instead of giving you my money,

right? And that, elsewhere, is a deep numb, its obvious at some level but we'll

spend a lot of time thiking it out and which of the methods, I've suggested

automatically builds it in NPV. So, NPV forces me to do everything right. And is

one number in the end. It's wrong, because it's based on expectations. But the

process of thinking is right. And if you have a very high positive number in the

NPV calculations, chances are that you're, it's found something valuable. Easy to

communicate. Now, this may be its strength. Yes, it's very easy to stand up

and say, you know, your rates of return in my idea is twenty%. I think everybody nods

and then everybody says, man, that's cool. So, it's easy to communicate, but is it?

By itself, it's very easy to communicate but to says is this value creating or not,

what do you have come out of it, this? So, in some sense, it's easy to communicate in

isolation but in value creation context, it's not. Look on how much time it took

trying to figure out, what is he trying to tell us. So, again, at a superficial level

like it makes sense at a real superficial level, its easy to communicate in a

superficial way. And, by the way, it's used left, right, and center. You know,

what's sad about it is even when we know it's a deceptive measure, we still use it.

And I'll come to that in a second. Is it easy to compare ideas? [unknown] says,

absolutely not. Because direct comparisons using IRR are extremely deceptive for I

just should you that two biases which are very devious, one is small, small scale,

it favors small mickey mouse ideas, and it favors the short term. Easy to calculate,

here is the tragedy of it. Answers, no, again. Why? Because we have to depend on

an Excel, because of compounding. So, the answer is, it is not even easy to

calculate, it's more difficult than NPV. So, any other thoughts, please feel free

to add. So, this, I want to wrap this session up on decision criteria with one

simple thought and that is if you use these, these criteria, these things listed

on the, in front of you to kind of evaluate the ones we have covered and ones

we have not covered and you can read it back, what you'll find is the one that

comes sticks out and still not perfect is NPV. Irr is used more so you have to be a

little bit careful when you're using IRR. If fact, I would say the following,

there's no need to use it, really, if you know how to do NPV. And that's where we'll

stop, we'll keep coming back to this issue later and I'll tell you when is it okay to

compare IRRs and when it's not. So, in the context of value creation, real projects,

it's trying to stay away from that, try to stay away from IRR. Why, beca use scales

are different, IRR is deceptive. [foreign] IRR is deceptive. And, by the way, if the

risks of the projects are different, IRR is also very deceptive. We'll get to that

later, but, because we haven't talked about risk. So, let's talk now, I know I'm

taking breaks in this time because IRR is tough to understand but this is a natural

break before we go to the next topic, which is cash flows. And remember, you can

start off right away, if you don't want a break. Stop now, I'll take a break, we'll

come back and start talking about the one ingredient common to all measures, is cash

flows, Talk to you soon. See you soon, bye.