A compound annual growth rate is a smoothed growth rate over a specified number of time periods. It is an important concept because it provides a better understanding of growth than a simple average growth rate. The formula for CAGR is: CAGR = ((Ending value / starting value) ^ (1 / (end time – beginning time))) – 1. For example, assume the following annual sales figures: Year 1 = $100,000 * Year 2 = $250,000 * Year 3 = $400,000 * Year 4 = $750,000 * Year 5 = $950,000. The CAGR is: CAGR = (($900,000 / $100,000) ^ (1/4)) – 1 = 75.6%. This shows that if sales grew 75.6% each year from $100,000, the ending value of sales in year five would be $950,000. Note the average growth rate in this example is 81%, which overestimates annualized return.
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