## What is a Hurdle Rate?

A hurdle rate, which is also known as minimum acceptable rate of return (MARR), is the minimum required rate of return or target rate that investors are expecting lớn receive on an investment. The rate is determined by assessing the cost of capitalUnlevered Cost of CapitalUnlevered cost of capital is the theoretical cost of a company financing itself for implementation of a capital project, assuming no debt. Formula, examples. The unlevered cost of capital is the implied rate of return a company expects to lớn earn on its assets, without the effect of debt. WACC assumes the current capital, risks involved, current opportunities in business expansion, rates of return for similar investments, và other factors that could directly affect an investment.

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Before accepting & implementing a certain investment project, its internal rate of return (IRR)XIRR vs IRRWhy use XIRR vs IRR. XIRR assigns specific dates lớn each individual cash flow making it more accurate than IRR when building a financial Model in Excel. should be equal to or greater than the hurdle rate. Any potential investments must possess a return rate that is higher than the hurdle rate in order for it khổng lồ be acceptable in the long run.

### What are the methods used to determine a hurdle rate?

Most companies use their weighted average cost of capital (WACC)WACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. as a hurdle rate for investments. The stems from the fact that companies can buy back their own shares as an alternative sầu lớn making a new investment, and would presumably earn their WACC as the rate of return. In this way, investing in their own shares (earning their WACC) represents the opportunity cost of any alternative sầu investment.

Another way of looking at the hurdle rate is that it’s the required rate of return investors demvà from a company. Therefore, any project the company invests in must be equal to or ideally greater than its cost of capital.

A more refined approach is khổng lồ look at the risk of individual investments & add or deduct a risk premium based on that. For example, a company has a WACC of 12% & half its assets are in Argentina (high risk), và half its assets are in the United States (low risk). If the company is looking at one new investment in Argentimãng cầu and one new investment in the United States, it should not use the same hurdle rate to lớn compare them. Instead, it should use a higher rate for the investment in Argentimãng cầu và a lower one for the investment in the U.S.

### What factors to lớn consider when setting a hurdle rate?

In analyzing a potential investment, a company must first hold a preliminary evaluation to thử nghiệm if a project has a positive net present value. Care must be exercised, as setting a very high rate could be a hindrance khổng lồ other profitable projects & could also favor short-term investments over the long-term ones. A low hurdle rate could also result in an unprofitable project.

Key considerations include:

**Risk premium**– Assigning a risk value for the anticipated risk involved with the project. Riskier investments generally have sầu greater hurdle rates than less risky ones.

**Inflation rate**– If the economy is experiencing mild inflation, that may influence the final rate by 1%-2%. There are instances when inflation may be the most significant factor to lớn consider.

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**Interest rate**– Interest rates represent an opportunity cost that could be earned on another investment, so any hurdle rate needs to be compared to real interest rates.

### How lớn use the hurdle rate lớn evaluate an investment?

The most comtháng way to lớn use the hurdle rate lớn evaluate an investment is by performing adiscounted cash flow (DCF)DCF Analysis InfographicHow discounted cash flow (DCF) really works. This DCF analysis infographic walks through the various steps involved in building a DCF Model in Excel. analysis. The DCF analysis method uses the concept of the time value of money (opportunity cost) to lớn forecast all future cash flows & then discount them baông chồng to today’s value to lớn provide the net present value.

In order to bởi vì this, the company needs khổng lồ perkhung some financial modelingWhat is Financial ModelingFinancial modeling is performed in Excel khổng lồ forecast a company"s financial performance. Overview of what is financial modeling, how và why khổng lồ build a Model.. The first step is to lớn model out all the revenues, expenses, capital costs, etc., in an Excel spreadsheet & develop a forecast. The forecast needs to lớn include the không tính phí cash flowFree Cash Flow (FCF)Free Cash Flow (FCF) measures a company’s ability khổng lồ produce what investors care most about: cash that"s available be distributed in a discretionary way of the investment over its lifetime. Onceall the cash flows are in place, use the XNPV function in Excel lớn discount the cash flows bachồng to lớn today at the mix hurdle rate. If the resulting Net Present Value (NPV) is greater than zero, the project exceeds the hurdle rate, & if the NPV is negative sầu it does not meet it.

As you can see in the example above sầu, if a hurdle rate (discount rate) of **12%** is used, the investment opportunity has a net present value of **$378,381**. This means if the cost of making the investment is **less** than $378,381, then its expected return will exceed the hurdle rate. If the cost is more than $378,381, then the expected return will be lower than the hurdle rate.

Learn more about rates of return in CFI’s financial modeling và valuation courses.

### How important is the hurdle rate in capital investments?

The hurdle rate is often phối to lớn the weighted average cost of capital (WACC)WACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity và debt., also known as the benchmark or cut-off rate. Generally, it is utilized to lớn analyze a potential investment, taking the risks involved & the opportunity cost of foregoing other projects into consideration. One of the main advantages of a hurdle rate is its objectivity, which prevents management from accepting a project based on non-financial factors. Some projects get more attention due to lớn popularity, while others involve sầu the use of new and exciting giải pháp công nghệ.

### What are the limitations of using a hurdle rate?

It’s not always as straightforward as picking the investment with the highest internal rate of return. A few important points to note are:

Hurdle rates can favor investments with high rates of return, even if the dollar amount (NPV) is very small.They may reject huge dollar value projects that may generate more cash for the investors but at a lower rate of return.The cost of capital is usually the basis of a hurdle rate và it may change over time.Xem thêm: Mách Nhỏ Những Thông Tin Về Đầu Số 095 Là Mạng Gì, Mách Nhỏ Những Thông Tin Về Đầu Số 095 Đặc Biệt

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