Written by:
Image
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades.

Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers. While there, Paul authored and edited thousands of financial research briefs, was published on Nasdaq. com, Yahoo Finance, and dozens of other prominent media outlets, and appeared as a guest expert at prominent radio shows and i...

View all posts
Updated August 12, 2020

What is the Hurdle Rate?

A hurdle rate is an investor's minimum rate of required return on an investment.

How Does the Hurdle Rate Work?

Let's assume Company XYZ is deciding whether to purchase a piece of factory equipment for $300,000. The equipment would last only three years, but it is expected to generate $150,000 of additional profit per year during those years. Company XYZ also thinks it can sell the equipment for scrap afterward for about $10,000. The company needs to determine whether the purchase is a better use of cash than some of Company XYZ's other investment options, which return about 10% (its hurdle rate).

Why Does the Hurdle Rate Matter?

A hurdle rate is the "line in the sand" that helps companies decide whether to pursue projects. Companies often use internal rate of return (IRR) to determine whether an investment exceeds a company's hurdle rate. Regardless of the calculation method, it is important to note that judging a project based on percentage returns can be dangerous. Hurdle rates can favor investments with high rates of return even if the dollar amount of the return is very small, for instance, and they can reject larger projects even though they may generate more cash for the investor. Thus, a $1 investment returning $3 will look more favorable than a $1 million investment returning $2 million.

It is also important to note that cash flows cannot always be reinvested at the project's rate of return. This is not always a realistic assumption, especially for investments with an unusually high return.

Ask an Expert about Hurdle Rate
At InvestingAnswers, all of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Hurdle Rate.
Be the first to ask a question

If you have a question about Hurdle Rate, then please ask Paul.

Ask a question

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers.

If you have a question about Hurdle Rate, then please ask Paul.

Ask a question Read more from Paul

Read this next

Paul Tracy - profile
Ask an Expert about Hurdle Rate

By submitting this form you agree with our Privacy Policy

Share
close
Don't Know a Financial Term?
Search our library of 4,000+ terms