Posted in Finance, Accounting and Economics Terms, Total Reads: 134
Definition: Hurdle Rate
Hurdle rate is the lowest rate of return which a company expects to get back from a business plan or any financial investment made. Mostly used in capital budgeting, hurdle rate is generally used by investors and managers to decide whether to proceed ahead with the project / investment or not. It is usually compared with internal rate of return (IRR). If IRR is greater than hurdle rate then it is advisable to go ahead with the project and otherwise not.
The Hurdle rate is calculated by summing up all the cost incurred by investing in the project resulting in a particulate rate of return known as hurdle rate. When a project or investment is proposed, the company calculates the expected rate of return i.e. IRR and compare it with hurdle rate (rejected if IRR is less than hurdle rate). This is to ensure that company at least earn back what it has invested (break-even), otherwise the project is considered non-profitable.
Another method to judge profitability of the project is by calculating net present value (NPV) by using hurdle rate as discount rate. If NPV comes out to be negative then the project is rejected.
Another factor which influence the hurdle rate is the risk involved. Higher the risk involved in the project, higher will be its hurdle rate and vice versa.