Hurdle rate

Definition

The hurdle rate is the minimum acceptable rate of return on an investment project set by management. It is used to determine whether a project should be pursued based on its potential to generate returns above this threshold.

5 Must Know Facts For Your Next Test

1. The hurdle rate is often aligned with the company's cost of capital.
2. It serves as a benchmark for evaluating the profitability of investment projects.
3. Projects exceeding the hurdle rate are typically considered, while those below it are rejected.
4. The hurdle rate can vary between different projects depending on risk levels.
5. It plays a crucial role in both Payback Period and Accounting Rate of Return methods.

Review Questions

• What role does the hurdle rate play in capital budgeting decisions?
• How might a company determine its hurdle rate?
• Why would different projects have different hurdle rates?

Related terms

Cost of Capital:

The required return necessary to make a capital budgeting project worthwhile.

Payback Period:

The time it takes for an investment to generate an amount of income or cash equal to the cost of the investment.

Accounting Rate of Return (ARR):

A measure of the profitability of an investment calculated by dividing average annual profit by initial investment cost.