Compound annual growth rate (CAGR) is a financial tool to gauge the rate of return of an investment over a given period of time. CAGR is also known as “smoothed” rate of return and it is calculated by taking the past performance of an investment and dividing it into an average annual rate of return.
Compound Annual Growth Rate (CAGR) Formula
The compound annual growth rate (CAGR) formula is used to calculate the average rate of return on an investment over a given period of time. The formula is calculated by dividing the value of an investment at the end of the period by its value at the beginning of the period, raising it to the power of one divided by the number of years and subtracting one.
CAGR = (Ending Value / Starting Value)1/n – 1
Where n = number of years.
Compound Annual Growth Rate (CAGR) Calculator
Using a compound growth rate calculator can save you time calculating the CAGR formula. With the calculator, you can enter the k initial value, the final value and the duration of the investment to explore the compound interest on investments.
Examples of Compound Annual Growth Rate (CAGR)
One example of a CAGR calculation is when a company has a sales growth of 12%, 10%, 8% and 8% over the last four years. To determine the CAGR of the company, we can use the formula as follows:
CAGR = (1.12 × 1.10 × 1.08 × 1.08)1/4 – 1 = 0.082 or 8.2%
In this example, the CAGR is 8.2%, which indicates the average rate of return the company obtained over the four years.
Compound Annual Growth Rate (CAGR) Advantages and Disadvantages
- Advantages
- Easy to calculate.
- Uses only two variables to determine the rate of return.
- Provides an average rate of return over a period of time.
- Gives an overview of a company’s growth rate.
- Disadvantages
- Does not take into account peaks and troughs in the investment.
- May not reflect the true rate of return if the time period is long.
- Does not give an accurate picture of the range of returns.
The CAGR is a powerful tool to gauge the rate of return of an investment. With a calculator and the formula, you can quickly determine the average growth rate to compare investments.
