Know Your Hurdle Rate Before Investing in New Projects

by Craig Anthony

1 min read

When you invest in a new project, you want to know if you can get the investment back and earn a profit. One useful tool for project financing and decision making is the hurdle rate, or minimum rate of return, which is what a project must achieve in return to cover any financing cost before reporting a profit. For example, you finance a new project with a loan at 15% and the project’s future cash flows are discounted at such a discount rate that the sum of their respective present value equals the project’s investment, or having a zero net present value, or NPV. The discount rate required is the hurdle rate, which tells you how the new project may or may not be profitable. If the hurdle rate used is 15% as the financing rate, you new project breaks even. If the hurdle rate is higher or lower than 15%, the project earns or loses money.The hurdle rate is related to a few other concepts used by financial analysts in project evaluation, or capital budgeting. You may view the hurdle rate as return on investment, or ROI, since the difference between a project’s hurdle rate and financing cost becomes the ROI for the project. You can also refer to the hurdle rate as internal rate of return, or IRR, when comparing costs of various financing rates. The IRR is essentially the maximum rate of financing cost a project can afford while still not losing any money.In applying the hurdle rate, you may want to look at payback period when you’re more concerned about cost recovery. This is most useful for a business with multiple projects. The payback period is the number of years it takes for a project to generate a sum of cash flows equal to the total cost of investment. You should choose the project with the shortest payback period if you want to recover the investment cost more quickly, despite not having the most ideal hurdle rate.

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