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Tuesday, May 17, 2011

CAGR and its Calculation

CAGR stands for compound Annual growth rate.
CAGR gives the consistent rate at which your investment grew over a period of time.
Suppose Rs. 1,00,000 grows to Rs. 1,50,000 over 3 years, then CAGR comes out to be 14.47 percent.
But this 14.47 % is an imaginary number which smoothes the actual returns achieved in last 3 years which were 20%, 8.3% and 15.4% respectively.
CAGR is used to ascertain a distinct rate of return over a period overlooking actual returns received in between.

How CAGR is calculated?

Amount= Principal* ((100+R)/100)n ....................(1)

Where R is the CAGR per annum and n is the period.
When compounding is not done annually but quarterly we replace R by R/4 and n by 4n, as there are 4 quarters in a year.
On simplifying (1) we get-

R=100*(Amount/Principal)1/n -100

  In the above example, by putting values-

We get, R=14.47 %

While calculating PEG ratio we use CAGR of Earning growth over a period.
CAGR gives us the bird’s eye view of the Earning growth over a very long period.


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