What is Compound Annual Growth Rate (CAGR)?

 

Compound Annual Growth Rate (CAGR) is the annual growth of your investments over a specific period of time. In other words, it is a measure of how much you have earned on your investments every year during a given interval. This is one of the most accurate methods of calculating the rise or fall of your investment returns over time.

Why is CAGR useful to you

Generally, people tend to look at returns in absolute terms. Imagine you have invested ₹1000 in a particular mutual fund for a period of three years. At the end of the third year, the value of your investment grew to ₹1,850. In absolute terms, your fund has generated a return of 85% over the three years. You could say that your money has nearly doubled during this period. However, this can be a bit misleading. It does not tell you how much your investment has actually grown over each year. This is where CAGR becomes very useful.

Here, let's calculate the CAGR to understand its benefits.

CAGR = [(1850/1000)^(1/3)] - 1

OR

CAGR = 23%

In other words, your investment in the fund has given you an average return of 23% every year over the last three years.

Essentially, CAGR lets you know the compounded returns you earn on an annual basis irrespective of the individual yearly performances of the fund.

This is because your investments do not grow at the same rate every year. Some years, you may have high returns while during other years, your returns may be lower. In fact, it is possible to earn negative returns too.

CAGR provides you with the information of the average returns earned by a fund every year in a certain time period. This is not a true rate of return. Rather, it is a representational figure of how much your investment growth provided they grew at the same rate every year

 

Conclusion

CAGR is a very useful method to calculate the growth rate of an investment. It can be used to evaluate the past returns or estimate the future returns of your investments. However, remember that CAGR works suitably for lump sum investments. In the case of Systematic Investment Plans (SIPs), it does not take the periodic investments into account as it only considers the initial and final values for the calculation. Overall, the CAGR calculator is a very useful tool and it can help you analyze your investments.\

 

Internal Rate of Return (IRR)

• The internal rate of return (IRR) is the annual rate of growth that an investment is expected to generate.
• IRR is calculated using the same concept as net present value (NPV), except it sets the NPV equal to zero.
• IRR is ideal for analyzing capital budgeting projects to understand and compare potential rates of annual return over time.

Return on Investment (ROI)

 

Return on investment—sometimes called the rate of return (ROR) is the percentage increase or decrease in an investment over a set period. It is calculated by taking the difference between the current or expected value and the original value divided by the original value and multiplied by 100.

For example, suppose an investment was initially made at $200 and is now worth $300. The ROI for this investment is 50% [((300 - 200) / 200) * 100].

Difference between IRR and ROI is that ROI indicates total growth, start to finish, of the investment. IRR identifies the annual growth rate.

 

Debt –Equity Ratio: Long Term Debt divided by Shareholders Equity

ROCE = EBIT / Capital Employed * 100

ROE = Net Profit After tax- Pr. Dividend / Shareholder equity or Net Worth

Import Export Code and Update IEC Code

 What is IEC

An Importer -Exporter Code (IEC) is a Business identification number that is mandatory for export from India or Import to India. No export or import shall be made by any person without obtaining an IEC unless specifically exempted. For services exports, however, IEC shall not be necessary except when the service provider is taking benefits under the Foreign Trade Policy.

Consequent to the introduction of GST, IEC being issued is the same as the PAN of the firm. However, the IEC will still be separately issued by DGFT based on an application. The nature of the firm obtaining an IEC may be any of the follows- Proprietorship, Partnership, LLP, Limited Company, Trust, HUF, Society.

Update IEC code by June 30, even if no Changes: DGFT

The Director-General of Foreign Trade (DGFT) has directed that all Import Export Code (IEC) holders are now legally required to update their IEC details every year from April to June online, even if there are no changes. An IEC shall be deactivated, if it is not updated within the prescribed time. IEC so de-activated may be activated, on its successful updation. This would however be without prejudice to any other action taken for violation of any other provisions of the FTP. An IEC may also be flagged for scrutiny. IEC holder(s) is required that any risks flagged by the system are timely addressed; failing which the IEC shall be deactivated. In other words, IEC shall be deactivated, if it is not updated within the prescribed time. IEC so de-activated may be activated, on its successful updation. This would however be without prejudice to any other action taken for violation of any other provisions of the FTP. IEC related provisions in Chapter-1 and Chapter-2 of Foreign Trade Policy, 2015-2020 are amended/ deleted and new provisions inserted. It is provided that An IEC holder has to ensure that details in its IEC is updated electronically every year, during the April-June period. In cases where there are no changes in IEC details the same also needs to be confirmed online. Therefore, do not forget to Update the IEC code by June 30, 2021.

TERMINAL VALUE V. DCF ANALYSIS

 

Terminal Value (TV)

Terminal Value

Terminal value is the value of an asset, business, or project beyond the forecasted period when future cash flows can be estimated. Usually, Terminal value assumes a business will grow at a constant growth rate forever after the forecast period. Terminal value often comprises a large percentage of the total assessed value.

KEY TAKEAWAYS

• Terminal value (TV) determines a company's value into perpetuity beyond a set forecast period—usually five years.
• Analysts use the discounted cash flow model (DCF) to calculate the total value of a business. DCF has two major components—the forecast period and terminal value.
• There are two commonly used methods to calculate terminal value—perpetual growth (Gordon Growth Model) and exit multiple.
• The perpetual growth method assumes that a business will continue to generate cash flows at a constant rate forever, while the exit multiple methods assume that the business will be sold for a multiple of some market metric.

 

Discounted cash flow (DCF) is a popular method used in feasibility studies, corporate acquisitions, and stock market valuation. This method is based on the theory that an asset's value is equal to all future cash flows derived from that asset. These cash flows must be discounted to the present value at a discount rate representing the cost of capital, such as the interest rate.

DCF has two major components: forecast period and terminal value. The forecast period is usually about five years. Anything longer than that and the accuracy of the projections suffer. This is where calculating terminal value becomes important.

Types of Terminal Value

 

Perpetuity Method

Discounting is necessary because the time value of money creates a discrepancy between the current and future values of a given sum of money. In business valuation, free cash flow or dividends can be forecast for a discrete period of time, but the performance of ongoing concerns becomes more challenging to estimate as the projections stretch further into the future. Moreover, it is difficult to determine the precise time when a company may cease operations.

To overcome these limitations, investors can assume that cash flows will grow at a stable rate forever, starting at some point in the future. This represents the terminal value. 

Terminal value is calculated by dividing the last cash flow forecast by the difference between the discount rate and terminal growth rate. The terminal value calculation estimates the value of the company after the forecast period.

The formula to calculate terminal value is:

(FCF * (1 + g)) / (d - g)

Where:

• FCF = Free cash flow for the last forecast period 
• g = Terminal growth rate 
• d = discount rate (which is usually the weighted the average cost of capital)

The terminal growth rate is the constant rate that a company is expected to grow at forever. This growth rate starts at the end of the last forecasted cash flow period in a discounted cash flow model and goes into perpetuity. A terminal growth rate is usually in line with the long-term rate of inflation, but not higher than the historical gross domestic product (GDP) growth rate.

What is the Importance of the Terminal Value?

In financial analysis, the terminal value includes the value of all future cash flows outside of a particular projection period. It captures values that are otherwise difficult to predict using the regular financial model forecast period.

There are two methods used to calculate the terminal value, which depends on the type of analysis to be done?

The exit multiple methods assume the business is sold for a multiple of some metric (e.g., EBITDA) based on currently observed comparable trading multiples for similar businesses.

The perpetuity growth model assumes that cash flow values grow at a constant rate ad infinitum. Because of this assumption, the formula for perpetuity with growth can be used. The perpetuity growth model is preferred among academics as there is a mathematical theory behind it.  However, it is difficult to agree on the assumptions that will predict an accurate perpetual growth rate.