hurdlerate

Hurdlerate, usually written hurdle rate, is the minimum acceptable rate of return that a business requires on a prospective investment. It functions as a benchmark for capital budgeting decisions and embodies the opportunity cost of capital along with the project’s risk. The hurdle rate is not a guaranteed return; it is a target used to decide whether to commit resources to a project or to pass.

Determination: Firms set hurdle rates by starting with the cost of capital (often the weighted average cost of capital, WACC) and adjusting for project-specific risk. Riskier projects typically carry higher hurdle rates, while safer or strategically important investments may use rates closer to the base cost of capital. Some organizations derive hurdle rates from CAPM-based required returns, internal hurdle schedules, or portfolio-based risk assessments. Hurdle rates may vary by project type, duration, size, or strategic priority.

Application and limitations: To evaluate a project, expected cash flows are discounted at the hurdle rate to compute the net present value (NPV). A positive NPV or an internal rate of return exceeding the hurdle rate generally supports approval. Potential drawbacks include sensitivity to the chosen rate, possible bias toward low-risk projects, and misalignment with real options or strategic benefits. Hurdle rates should be reviewed regularly to reflect changes in capital costs and risk assessments.