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Compounded Annual Growth Rate

What is Compounded Annual Growth Rate?

The Compounded Annual Growth Rate (CAGR) is the rate of return required for an investment to grow from its beginning balance to its ending balance over a specified period, assuming profits are reinvested at the end of each period. It provides a smoothed annual growth rate, offering a clearer picture of an investment's performance over time and allowing for accurate comparisons between different investments.

Calculating CAGR: A Step-by-Step Guide

To calculate CAGR, use the formula:

CAGR=(EV/BV)1/n−1

Where:

  • EV = Ending value of the investment
  • BV = Beginning value of the investment
  • n = Number of years

CAGR vs. Simple Growth Rate: Understanding the Difference

CAGR differs significantly from the Simple Growth Rate in that it accounts for the time value of money, compounding the returns each year. In contrast, the Simple Growth Rate calculates the total percentage increase divided by the investment period, ignoring the effects of compounding. CAGR offers a more detailed and accurate portrayal of growth, making it superior for comparing the performance of investments over multiple periods.

Key Applications of CAGR in Business Strategy

CAGR is extensively used in business strategy for various purposes:

  • Comparing Investments: It allows for the comparison between different investments over identical time periods by normalizing the growth rates.
  • Tracking Business Performance: Companies use CAGR to track the growth of sales, market share, or customer base over time, providing insights into the effectiveness of business strategies.
  • Strategic Planning: CAGR helps in identifying trends and forecasting future growth, which is crucial for long-term planning and resource allocation.

The Impact of CAGR on Investment Decisions

The Compound Annual Growth Rate (CAGR) significantly impacts investment decisions by providing a clearer picture of an investment's performance over time. This allows investors to compare different investment options and make informed choices. However, it's essential to remember that CAGR does not account for investment risk or volatility.

Other terms

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