What is Compounded Annual Growth Rate? Explained Formula, calculation in excel.

 

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Author: Sarthak Bhalerao

Table of Contents

  1. What is the Compound Growth Rate?
  2. The formula for Compound Growth Rate
  3. Meaning of Compounded Growth rate
  4. How to do calculate CAGR in excel?
  5. Example
  6. Bonus Lesson- Compounding in Practice

1:What is the Compound Growth Rate?

The compound growth rate indicates the growth rate of any asset over multiple periods. The compound growth rate is used in many business and investing contexts. It is the constant measure of the growth of a data series. As the name suggests, the compound growth rate takes into consideration the compounding effect. This is the most significant advantage of the compound growth rate. As a result, it is essential to assess and calculate returns from various investments. Unlike average growth rates prone to volatility, compound growth rates are not affected by volatility levels. Therefore, they are highly accurate and more relevant in comparing different data series.

2: Compound Growth Rate Formula

The formula for calculating the compound growth rate is:

Where:

  • Vn – Ending value
  • V0 – Beginning Value
  • n – Total number of periods

3:Understanding the Compound Annual Growth Rate (CAGR)

The Compound Annual Growth Rate (CAGR) is one of the most frequently used metrics in financial analysis and financial modelling. In financial models, the CAGR is calculated for important operational metrics such as EBITDA and also for calculating capital expenditure (Capex) and revenue. The CAGR can also be used for the forecasting of future growth rates. However, one should be very careful in using the compound growth rate in financial analysis as the metric smooths the historical data, omits the effect of volatility, and implies the steady growth of the data series. For e.g., if the return for year 1 is 25% and year 2 is only 5%, The CAGR for two years would come out to be 15%. Due to these reasons, the compound growth rate should best be used together with some other metric, and the context of the given situation must always be considered. 

4:How to caculate CAGR in excel with Example

Caclulating CAGR in excel is preety simple, yet can be tricky because there are many ways to do it. 

  1. Manual
  2. Function

Manual: Manually you can use the same formula which we discussed above For the example given below.

Five years ago, Alex invested $10,000 in the stocks of ABC Corp. & In year 5 the value becomes $11500/

  • Year 1: $10,500
  • Year 5: $11,500

Alex wants to determine the steady growth rate at which his investment rose over the five years. In this case, the compound growth rate equals the compound annual growth rate. The CAGR of his investment would be:

 

Over the five-year period, Alex’s investment grew by 2.8%

5:Compounding in Practice:check this detailed lesson of compounding in practice

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Sarthak Bhalerao

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