What is the Hurdle Rate?
A hurdle rate is an investor's minimum rate of required return on an.
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 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 than some of Company XYZ's other 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 exceeds a company's hurdle rate. Regardless of the calculation method, it is important to that judging a project based on percentage returns can be dangerous. Hurdle rates can favor 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 for the investor. Thus, a $1 returning $3 look more favorable than a $1 million returning $2 million.
It is also important to rate of return. This is not always a realistic assumption, especially for with an unusually high return.that flows cannot always be reinvested at the project's