XXXX A Basic Overview of XIRRXXXX

A Basic Overview Of XIRR

FEB 2013

XXXX XXXXXXXX

Document No.Ver. Rev. :

Authorized by:Signature/:Date:

Author(s): DEBARKA CHAKRABORTY (XXXXXX)

Date written (MM/DD/YY): 02/21/2013Project Involved: XXXXXXX

Declaration: I hereby declare that this document is completely based on my personal knowledge gathered from different sources including online media but presented through self-made statements and examples. This document does not contain any material that infringes the copyrights of any other individual or organization to the best of our knowledge.

Target Readers: All, whoever interested to understand ones return on financial investmentsKeywords: Banking, Investments, XIRR, Rate of return

Prerequisite Knowledge: Basic mathematical knowledge of compound interest

CONTENTS

IntroductionPurpose of this documentKey WordsDescription of the XIRR functionRules to RememberExplanation using examplesAttached Excel Workbook with ExamplesConclusion

INTRODUCTION

All of us deal with cash, be it less or more. We also park our funds at different financial instruments be it savings accounts, fixed deposits or market-linked avenues. So the rate of return is a term of quite importance. The rate of return dictates our inclination for a particular investment.So, measurement of the return of a certain investment becomes essential. Here the concept of rate of return and the MS Excel function called XIRR comes into picture. It provides an easy way to calculate and measure your return on your investments.

Purpose of this Document

This document is meant to enable individuals to measure their return on investments on any time-frame period. A simple MS Excel function and its effective use can empower retail investors or any given individual to measure his/her cash growth on any investment.

KEY WORDS

Before moving any further, it is necessary to familiarize the readers with certain keywords which they might not be aware of. The knowledge of some financial terms is imperative for the proper and effective understanding of this matter.

Those are listed as follows CASH FLOW NPV (Net Present Value) Capital Budgeting IRR (Internal Rate of Return) XIRR (Extended Rate of Return) CAGR (Compounded Annual Growth Rate)

CASH FLOWIn simple terms, cash flow is simply the inflow and outflow of cash for an individual or a managed company. It can be defined as a revenue or expense stream that changes handsover a given period of time. Cash inflows and outflows usuallyarise from one of three activities - financing, operations or investing. For a business firm, cash flow is essential to generate growth. Companies with ample cash on hand are able to invest the cash back into the business in order to generate more cash and profit.

NPV (Net Present Value) NPV compares the value of a rupee today to the value of that same in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.It is defined in financial terms as the difference between the present value of cash inflows and the present value of cash outflows. These cash flows are of the project/investment to be done.Simply, we can put NPV as the present value of the future cash flows.

Capital BudgetingCapital budgeting (or investment appraisal) is the planning process used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are worth pursuing. It is budget for major capital, or investment, expenditures.

IRR (Internal Rate of Return)The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments.It is the interest rate at which the net present value of all cash flows (both inflow and outflow) that would accrue from an investment equal to zero. IRR is the rate of growth a project/investmentis expected to generate.IRR is used to evaluate the attractiveness of a project/investment. If the IRR of the investment (or a companys project) exceeds the required rate of return, that project is desirable; else if the IRR falls below the minimum required rate of return, the project needs to be scrapped/rejected.The term internal refers to the fact that its calculation does not incorporate environmental factors such as the interest rate of inflation, forex rates, etc.,.

XIRR (Extended Rate of Return)XIRR is very similar to IRR except some minor differences.XIRR returns the internal rate of return for a schedule of cash flows (be it cash inflow or cash outflow) that is not necessarily periodic. XIRR calculation is based on a 365 days per year basis, ignoring leap years.The calculation for IRR works fine for periodic cash flows (say each month frequency), payments taking place at regular intervals, but for aperiodic cash flows, XIRR function is needed.The input argument in XIRR function contains the date of cash flow. These dates need not be in a periodic form.

CAGR (Compounded Annual Growth Rate) The compounded annual growth rate (CAGR) is the year-over-year growth rate of an investment over a specified period of time. It provides the smoothed annualized gain of an investment over a given time period.The following formulae is used to evaluate the CAGR of any investment, where ending value is the final amount after # no. of years and beginning value is the initial value of investment.CAGR = (Ending Value / Beginning Value)^( 1 / # of years) - 1

Suppose an initial investment of Rs.1000 grows to Rs.1950 in 3 years, then the smoothed annualized return on the investment is given by the above formula.CAGR = [(1950/1000) ^0.33] - 1 = 0.2493 = 24.93%CAGR basically smoothes the compounded return for the specified period of time. If the initial amount would have grown by this CAGR it would have reached this final value in the time span specified.Thus, it is an effective financial tool for individuals to gauge their investment return on an annual basis. A good CAGR return on investments is a positive measurement of the financial health of the investor.

Description of the XIRR FunctionAmong the many useful arithmetic functions present in MS Excel, XIRR is a function of special importance. It is a highly effective tool when comes to evaluate and measure the return of investments which are effected at irregular intervals.XIRR returns the internal rate of return for a series of cash flows which may be periodic or may not be. On the other hand, IRR function only evaluates the rate of return for periodic cash flows. The syntax used for XIRR is XIRR (cash values, dates of cash flows, guess for iteration)Cash values are the amount of cash which is invested or withdrawn on a certain date.Dates of cash flows refer to the corresponding dates when the cash flows are transacted.Guess for iteration is an initial guess of the rate of return (preferably between 0 and 1).

Rules to Remember

There are a few important points to remember: 1. The first entry under the cash values column must have the earliest date. 2. Later entries may be in any order (so long as they don't have a date earlier than the first entry). 3. Investments are entered as positive amounts and withdrawals as negative amounts. 4. The current/final portfolio is entered as a negative amount. 5. You make some initial guess at the correct answer (like 0.1, meaning 10%).This is required for the iterative process to assume an initial value. Any other valid value (above 0) would also yield the correct result. The return generated by XIRR is an annualized return (over the period defined by the dates). Annualized return has been explained under CAGR.

Explanation using examplesWell, our explanation of the implementation of the XIRR function of MS Excel can be best understood if we fathom the objective it serves.Our objective is to evaluate the rate of return of a series of cash flows (both inflows and outflows) which are made at irregular intervals over a span of time.

Let us consider the following scenarios.Exhibit 1: Mr. X wants to know the rate of return of his investments for the past few years.Refer to attached Excel Workbook.

Exhibit 2: Let us now see a model investment scenario, such as a simple endowment Life Insurance policy bought by Mr. X. He pays Rs. 10000 half-yearly as premium for tenure of 21 years for a sum assured of Rs. 500000. The maturity amount is said to be Rs. 1000000.He wants to know how good his investment is by evaluating its rate of return.Refer to attached Excel Workbook.

Exhibit 3: Let us visualize a typical Recurring Deposit Scheme offered by a Bank. A monthly deposit of Rs. 5000 for a period of 2 years matures at Rs. 132000.Refer to the attached Excel workbook for the rate of return.

Attached Excel Workbook with Examples

ConclusionThis document is solely meant to empower the readers with the concept of rate of return and the implementation of XIRR function. The examples used are totally fictitious and bears no resemblance to any prevailing financial portfolio of any individual.This document would enable readers to calculate the future rate of return of their financial investments. Thus choosing between different investment decisions would get easier. This would result in better capital returns and capital growth.At the end of the day, its more money that one can generate. So, use XIRR function and go happy investing!!!! XXXX XXXX XXXX, India

Exhibit 1Mr. X wants to know the rate of return of his investments for the past few years.His cash flows are enumerated as follows

Deposit/WithdrawalDate10002-Jan-1020003-May-10All the positive values under deposit/withdrawal are cash inflows or his investments, while the negative values are the withdrawals.The final value in field A12 is negative because it is the present worth of his investments.Here, the present worth of his invested money is Rs 12500.Double click on field B13 to see the XIRR formulae used.-30014-Jul-10-213026-Jan-11450013-Mar-11670012-Aug-12-150028-Apr-12-1250015-Feb-130.141567140814.16%

Exhibit 2Let us now see a model investment scenario, such as a simple endowment Life Insurance policy bought by Mr. X. He pays Rs. 10000 half-yearly as premium for tenure of 21 years for a sum assured of Rs. 500000.The maturity amount is said to be Rs. 1000000.He wants to know how good is his investment by evaluating its rate of return

Deposit/WithdrawalDate1000010-Oct-121000010-Apr-131000010-Oct-131000010-Apr-14One can clearly see that the premium dates are spaced at 6 months intervals.The investor pays 42 premiums for 21 years and gets double the sum assured value on 10-OCT 2033 when the policy matures.But the rate of return is a mere 7.46% which may just beat the inflation (or maybe not).Thus one must check the rate of return of one's investment before zeroing onto one.A CAGR return post-tax of 8-9% is a decent return.1000010-Oct-141000010-Apr-151000010-Oct-151000010-Apr-161000010-Oct-161000010-Apr-171000010-Oct-171000010-Apr-181000010-Oct-181000010-Apr-191000010-Oct-191000010-Apr-201000010-Oct-201000010-Apr-211000010-Oct-211000010-Apr-221000010-Oct-221000010-Apr-231000010-Oct-231000010-Apr-241000010-Oct-241000010-Apr-251000010-Oct-251000010-Apr-261000010-Oct-261000010-Apr-271000010-Oct-271000010-Apr-281000010-Oct-281000010-Apr-291000010-Oct-291000010-Apr-301000010-Oct-301000010-Apr-311000010-Oct-311000010-Apr-321000010-Oct-321000010-Apr-33-100000010-Oct-330.07460174867.46%

Exhibit 3Let us visualize a typical Recurring Deposit Scheme offered by a Bank.A monthly deposit of Rs. 5000 for a period of 2 years matures at Rs. 1,32,000.Let us get the CAGR or the rate of return (here CAGR and rate of return gets same because of the periodic investments)

Deposit/WithdrawalDate50001-Sep-1150001-Oct-1150001-Nov-11The rate of return of this RD is quite good at around 9.5%.50001-Dec-1150001-Jan-1250001-Feb-1250001-Mar-1250001-Apr-1250001-May-1250001-Jun-1250001-Jul-1250001-Aug-1250001-Sep-1250001-Oct-1250001-Nov-1250001-Dec-1250001-Jan-1350001-Feb-1350001-Mar-1350001-Apr-1350001-May-1350001-Jun-1350001-Jul-1350001-Aug-13-1320001-Sep-130.09421137879.42%