What is the difference between"interest rate and IRR"in car loan?
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To understand this you first have to understand the concept of principle of "Time Value of Money".
Lets say you have 100 rupee in your hand and want to lend it some one and let's say you have lent on 10 percent for one year. Which means you will get 110 at the end of 1 year. So we have an equation:
100 = 110 after 1 year @ 10%.
Now what is this 10% or 10 rupees? Its is nothing but "time value of money" because you have parted with your money for 1 year. This concept is culmination of inflation and erosion in value of money.
So in our example if lets say we can buy X thing today in 100 bucks, then with an inflation of 10% the same thing will cost us 110 after 1 year, which means virtually 100 bucks today are equal to 110 after 1 year. Why? Coz value of money erode with time.
So interest is nothing but that value of erosion in money. That's why in inflationary market interests rates are high. More inflation more interest rates.
Coming to IRR or Internal Rate of return. IRR is basically a rate at which today's money is equal to tomorrow's money and there is no profit or loss.
Take our above example. If we have lent 100 rupees to some one with a promise that he will give us 110 at the end of 1 year then we have an IRR of 10% coz at an IRR of 10%, 100 today is equal to 110 after one year.
IRR method is used to see the viability of any project and is widely used as a business application. Even let's say in our 100 buck example, if we had taken the money on 8% then we are at a profit of 2% coz our IRR is 10% but cost is 8%. In the same way ppl calculate IRR and compare the same with cost of capital associated with the project.
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