Compound Annual Growth Rate (CAGR) Definition
What is CAGR? Definition
Definition: Compound annual growth rate (CAGR) is used for the calculation of financial investment that the investment increases or decrease year over year. Simple we can say that from this we get the average return of an investment over the time period.
For an investment average return from year to year that may be good average return or bad average return.
CAGR calculate both good and bad average return percentage at one place and give the result. This result from CAGR is used to making financial decisions for the future by the investors and management.
Compound annual growth rate (CAGR) is not considered as an actual annual return rate. It used to average all the return which gain on the investment.
It is used for the rate out of many years which may by compare with other investment opportunities.
Compound Annual Growth Rate (CAGR) Formula
For the calculation of the CAGR, we need to divide the ending value by the beginning investment value to find the total growth rate. Then use the other room which is numbers of years for investment. Then product these to and from this subtract 1 to find CAGR.
CAGR= (ending investment value/beginning investment value)(1/number of years) – 1
There is two part in the above equation. The first part uses to calculate the total return. The second part is used to measure the annual return over the life of the investment.
Now we take the example of Simond’s auto manufacturing plant which invests $75,000 for new equipment. $25,000 of work he gets from the capital investment instead of considering saving which considre in labour cost.
Ending value of this investment is 100,000 dollars. Now from the given value, you can see how to calculate CAGR?
From the above result, we observe that Simond made an average of 5.86% on his investment in new equipment.
If we consider this earing the same in 5 years then it means that every year he made 5,86%. For the simplification of the example here we not consider the effect of labour-saving on the return.
Simond put some of the company profit in the stock of the company. He purchases stock of 35000 dollars five years ago.
When he bought shares then after that immediately market down and hid investment down to 20,000 dollars for 4 years. In the fifth year the market up and share worth is 50,000 dollars.
From this, we can calculate the Simond’s growth rate investment for the stock as
First four year Simond get the loss but due to getting profit in the fifth year he gets success to achieve the 7.39% growth rate years over years.
When we compare the stock investment with capital investment because Simond gets the good result by investing all the money of company in the stock because with the stock purchase he makes money 1.53 more.
Analysis and Interpretation
What is CAGR use for?
For the analyst and for management CAGR helps to compare the investment based on its returns. It not important that what the original amount of investment. Mostly CAGR calculator use by the management to compare the 1million dollar capital investment in equipment to 50,000 dollars investment in the new building. Through this management or invest money to get the possible high return.
Investors and management invest their money to get the opportunity of high return back. High CAGR percentage better than low CAGR percentage.
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