How to Calculate Compound Annual Growth Rate

Compound annual growth rate, at first take, is a term that seems shrouded in a cloud of financial lingo. This powerful financial tool is best explained by following an example that demonstrates the math used. Follow these steps to understand the proper calculations.

Instructions

Difficulty: Moderately Challenging

Things You’ll Need:

• Calculator capable of computing fractional powers

1. Establish the initial investment. In this case we will use $20,000 that was invested three years ago.
2. Illustrate year one ending amount. In the present example used, the initial investment has grown to $27,000.
3. Record year two ending balance. In this case the ending balance was $28,000.
4. Ascertain ending value for year three. The ending balance in this situation is $32,000. Now this formula can be used for an infinite number of years, months or whichever time frame is needed. In the present example, three years is being used.
5. Calculate the compound annual growth rate. First take the ending amount of the investment, $32,000, and divide by the initial investment amount, $32,000. The resulting figure is 1.6.
6. Raise the previous figure to the power of 1/number of time periods invested, or in this case the period is three years. This figure can be defined as 1.6^.3333. The resulting figure is 1.16777.
7. Subtract to previous figure from 1. The previous number was 1.1677 and subtracted from 1 equals .1677. Therefore the compound annual growth rate is 16.77% for this example.