Hurdle rate
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A hurdle rate is an organisation's minimum rate of return used for determining the viability of a proposed investment or other project.
The hurdle rate can be used in two ways:
- As a target Internal rate of return, that proposals need to exceed.
- As a discount rate (r) to apply in Net present value analysis, to discount the future cash flows.
- Example 1 - Internal Rate of Return (IRR)
- Our organisation's hurdle rate is 7%.
- A proposal has an Internal rate of return of 5%.
- The IRR is lower than our hurdle rate.
- Accordingly, the proposal is rejected.
- Example 2 - Net Present Value (NPV)
- Our organisation's hurdle rate is 7%.
- We use 7% to discount a proposal's future cash flows.
- If the Net present value is less than 0, the proposal will be rejected.
Hurdle rates are usually set with reference to the organisation's weighted average cost of capital.
This will depend on a number of factors, including currency and the risk free rate of return in the relevant currency.
Hurdle rates may be adjusted for different classes of project, with different levels of risk.
Riskier projects, or classes of project, would be allocated a higher hurdle rate.
