Choose the correct statement about CAGR(compound annual growth rate)?

CAGR (Compound Annual Growth Rate) represents the steady growth rate an investment would need to grow from its starting value to its ending value over a period of time.

If an investment of ₹100 became ₹200 in 3 years, CAGR determines what constant percentage growth rate would achieve this result in exactly 3 years.

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The CAGR formula is:

$CAGR = \left(\frac{\text{Ending Value}}{\text{Beginning Value}}\right)^{\frac{1}{n}} - 1$

where $n$ = number of years

The formula requires the Beginning Value and Ending Value as the two main inputs.

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Option 1: "CAGR is the average annualized return of an investment."

While CAGR does provide an annual rate, calling it simply "average" is misleading. CAGR is specifically a geometric average, not a simple average. This statement lacks precision.

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Option 2: "CAGR is calculated by taking arithmetic mean of series of returns."

This is incorrect. Arithmetic mean involves adding all returns and dividing by the number of returns. CAGR uses geometric mean which accounts for compounding effects. If an investment increases 50% then decreases 50%, arithmetic mean suggests 0% return, but the investment actually lost value. CAGR properly accounts for this.

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Option 3: "CAGR is linear measure that does not account for the effects of compounding."

This is incorrect. The "C" in CAGR stands for "Compound." CAGR specifically accounts for compounding, which is its primary purpose over simple averages.

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Option 4: "CAGR is calculated by using the final and beginning value of an investment."

This is correct. The CAGR formula requires the Ending Value and Beginning Value as the critical inputs, along with the time period.

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The answer is Option 4.

The CAGR formula requires the beginning value and ending value of the investment as the essential inputs. The time period indicates how many years passed between these values.