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The hurdle rate is the minimum rate of return that must be met for a company to undertake a particular project. The hurdle rate is usually determined by evaluating existing opportunities in operations expansion, rate of return for investments, and other factors deemed relevant by management. A risk premium can also be attached to the hurdle rate if management feels that specific opportunities inherently contain more risk than others that could be pursued with the same resources. A problem with using a hurdle rate that is too large is that profitable projects will be turned down. As well, a hurdle rate that is too large will bias the firm in favor of short-term projects over long-term projects. Thus, a common method for evaluating a hurdle rate is to apply the discounted cash flow method to the project and then compare that figure against returns that would be available if the same resources were invested in securities.

The hurdle rate is frequently used as synonym of cutoff rate, benchmark and cost of capital.[1]

Reference:

   1. ^ Ross, Stephen A., Westerfield, Randolph W., Jaffe, Jeffrey, Corporate Finance, Seventh Edition, McGraw Hill International Edition, 2005, Page 330.

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Categories: Corporate finance

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